**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-K/A**

**(AmendmentNo.  1)**

 

| **(Mark One)**                                       |
|------------------------------------------------------|
| ý                                               | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| **For the fiscal year ended January 31,  2004** |
| **or**                                               |
| o                                                    | ** ** | **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.** |
|-----------------------------|------------|---------------------------------------------------------------------------------------------------|------------|-----------------------------------------|
| **333-42427**               | ** ** | **J. CREW GROUP, INC.**                                                                           | ** ** | **22-2894486**                          |
| ** **                  | ** ** | **(Incorporated in New York)  770 Broadway  New York, New York 10003  Telephone: (212) 209-2500** | ** ** | ** **                              |
| **333-42423**               | ** ** | **J. CREW OPERATING CORP.**                                                                       | ** ** | **22-3540930**                          |
|                        |       | **(Incorporated in Delaware)  770 Broadway  New York, New York 10003  Telephone: (212) 209-2500** |       |                                    |
| **333-107211**              |       | **J.CREW INTERMEDIATE LLC**                                                                       |       | **N/A**                                 |
|                        |       | **(Formed in Delaware)  770 Broadway  New York, New York 10003  Telephone: (212) 209-2500**       |       |                                    |

 

Securities Registered Pursuant toSection 12(b) of the Act: **None**

 

Securities Registered Pursuant toSection 12(g) of the Act: **None**

 

Indicate bycheck mark whether each registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes ý  No o

 

Indicate bycheck mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of each registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K. ý

 

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

 

The commonstock of each registrant is not publicly traded. Therefore, the aggregatemarket value is not readily determinable.

 

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

 

Documentsincorporated by reference:    **None**

 

J. CrewOperating Corp. and J.Crew Intermediate LLC meet the conditions set forth inGeneral Instruction (I)(1)(a) and (b) of the Form 10-K and are thereforefiling this Form 10-K/A withthe reduced disclosure format.

 

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EXPLANATORY NOTE

J. Crew Group, Inc., J. Crew Intermediate LLC, andJ. Crew Operating Corp. (the "Registrants") are filing this AmendmentNo. 1 to their Annual Report on Form 10-K for the year endedJanuary 31, 2004 (this"Form 10-K/A") to reflect the write-off of certain prepaid samplecosts that should have been expensed as incurred. As a result of this revision,the Registrants are restating their consolidated financial  statementsfor the fiscal year ended January 31, 2004. For a detailed description of the  effect ofthe restatement, see Note 2 to the consolidated financial statements accompanying this Amendment.

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

**FILING FORMAT**

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

Referencesherein to fiscal years are to the fiscal years of J. Crew Group, Inc., J.Crew Intermediate LLC and J. Crew Operating Corp., which end on the Saturdayclosest to January 31 in the following calendar year for fiscal years1999, 2000, 2001, 2002 and 2003. Accordingly, fiscal years 1999, 2000, 2001,2002 and 2003 ended on January 29, 2000, February 3, 2001,February 2, 2002, February 1, 2003 and January 31, 2004. Allfiscal years for which financial information is included had 52 weeks, exceptfiscal year 2000 which had 53 weeks.

**PART I**

**BUSINESS**

***In this section, “we,” “us” and “our” referto Group and our wholly ownedsubsidiaries, including Operating Corp. and Intermediate.***

**General**

We are anationally recognized retailer of women’s and men’s apparel, shoes, andaccessories sold under the “J. Crew” brand name. Started in 1983, we have builtand reinforced our brand name and image through the circulation of catalogsthat use magazine-quality photography to portray a classic American perspectiveand aspirational lifestyle and the operation of our stores and internetwebsite. We believe that the “J. Crew” brand name is widely recognized for itstimeless styles at price points that represent exceptional product value. Weoffer a full line of men’s and women’s clothing, including basic durables(casual weekend), workwear (casual weekday), swimwear, sport, accessories andshoes to meet our customers lifestyle needs. Many of the original itemsintroduced by us in the early 1980s (such as the rollneck sweater, weatheredchino, barn jacket and pocket tee) were instrumental in establishing the J.Crew brand and continue to be our core product offerings.

J. Crewproducts are distributed exclusively through our retail and factory stores, ourcatalog and our internet website located at www.jcrew.com. As ofJanuary 31, 2004, we operated 154 retail stores and 42 factory outletstores in the United States. We believe that our customer base consistsprimarily of college-educated, professional and upscale customers who in ourexperience have demonstrated strong brand loyalty and a tendency to makerepeated purchases. In addition, J. Crew products are distributed through45 freestanding and shop-in-shop stores in Japan under a licensingagreement with Itochu Corporation.

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

•              $408.1 millionfrom J. Crew Retail;

•              $173.5 millionfrom J. Crew Direct; and

•              $79.0 millionfrom J. Crew Factory.

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

**Merchandising and Design**

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

All of ourproducts are designed by an in-house design staff to reflect a classic, cleanaesthetic that is consistent with our American lifestyle brand image. Designteams are formed around J. Crew product lines and categories to developconcepts, themes and products for each of our J. Crew businesses. Our technicaldesign teams develop construction and fit specifications for every product toensure quality workmanship and consistency across product lines. These teamswork in close collaboration with the merchandising, production and qualityassurance staffs in order to gain market and other input and ensure quality ofthe J. Crew products.

**Sourcing and Production**

Ourmerchandise is produced for us by a variety of manufacturers in 23 countries.We do not own or operate any manufacturing facilities and instead contract withthird-party vendors for production of our merchandise. In fiscal 2003,approximately 80% of our merchandise was sourced in Asia, 5% was sourced in theUnited States and 15% was sourced in Europe and other regions. Any eventcausing a sudden disruption of manufacturing or imports from China, includingthe imposition of additional import restrictions, could have a

 

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material adverse impact on our operations. In addition, one vendorsupplies approximately 20% of our merchandise, but we believe that the loss ofthis vendor would not have a material adverse impact on our ability to sourceour products. Substantially all of our foreign purchases are negotiated andpaid for in U.S. dollars.

 

We cannot predict whether anyof the countries in which our merchandise is currently produced or may beproduced in the future will be subject to additional trade restrictions imposedby the United States and other foreign governments, nor can we predict thelikelihood, type or effect of any such restrictions. Trade restrictions,including increased tariffs or quotas, against apparel and other items sold byus could increase the cost or reduce the supply of merchandise available to usand adversely affect our business, financial condition and results ofoperations. Our sourcing operations may also be adversely affected by politicaland financial instability in any country in which our goods are produced or byacts of war or terrorism in the United States or worldwide to the extent theseacts impact the production, shipment or receipt of merchandise. Sourcingoperations may also be adversely affected by significant fluctuation in thevalue of the U.S. dollar against foreign currencies or restrictions on thetransfer of funds.

 

**Distribution**

 

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

 

We ship merchandise via theUnited States Postal Service and FedEx. To enhance efficiency, each facility isfully equipped with an advanced telephone system, automated warehouse locatorsystem and inventory bar coding system. In addition, our Lynchburg facility hasautomated packing and shipping sorters.

 

**Information Systems**

 

Our management informationsystems are designed to provide, among other things, comprehensive orderprocessing, production, accounting and management information for themarketing, manufacturing, importing and distribution functions of our business.We have point-of-sale registers in our retail and factory outlet stores thatenable us to track inventory from store receipt to final sale on a real-timebasis. We believe our merchandising and financial systems, coupled with ourpoint-of-sale registers and software programs, allow for rapid stockreplenishment, concise merchandise planning and real-time inventory accountingpractices. Our telephone and telemarketing systems, warehouse package sortingsystems, automated warehouse locator and inventory bar coding systems utilizeadvanced technology. These systems have provided us with a number of benefitsin the form of enhanced customer service, improved operational efficiency andincreased management control and reporting. In addition, our real-timeinventory systems provide inventory management on a stock keeping unit basisand allow for an efficient fulfillment process.

 

We have installed a SAPenterprise resource planning system for our information technologyrequirements. This system was implemented in fiscal years 2000 and 2001. Infiscal 2000, our accounting systems were implemented. A corporate-widepurchasing system, a retail sales and inventory system (including newpoint-of-sale registers) and a human resource and payroll system were completedin fiscal 2001. In November 2000, we outsourced our data center, desktop,network and telecommunication services management and operations support. InFebruary 2001, we outsourced the hosting and support of our internetwebsite to a third-party vendor.

 

**Trademarks and Licensing**

 

The “J. Crew” trademark andvariations thereon, and certain other trademarks, are registered or are subjectto pending trademark applications with the United States Patent and TrademarkOffice and with the registries of many foreign countries.

 

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

 

**Employees**

 

As of January 31, 2004, wehad approximately 5,500 associates, of whom approximately 1,700 were full-timeassociates and 3,800 were part-time associates. In addition, approximately1,900 associates are hired on a seasonal basis to meet demand during thepeak season. None of our associates are represented by a union. We believe thatour relationship with our associates is good.

 

**Competition**

 

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

 

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

 

•              adverseeconomic conditions;

 

•              thelevels of disposable consumer income;

 

•              consumerconfidence; and

 

•              interestrates.

 

**Our Business**

 

***J. Crew Retail***

 

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

 

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

 

•              geographiclocation;

 

•              demographicinformation;

 

•              anchortenants in mall locations; and

 

•              proximityto other specialty retail stores in mall and street locations.

 

J. Crew Retail stores that wereopen during all of fiscal 2003 averaged $2.7 million per store in salesand produced sales per gross square foot of $345. J. Crew Retail stores have anaverage size of 7,680 total square feet.

 

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

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

 

***J. Crew Direct***

 

J. Crew Direct consists of ourcatalog and internet website operations. During fiscal 2003, J. Crew Directgenerated $173.5 million in revenues, including $61.9 million fromthe catalog and $111.6 million from the internet website, representing25.2% of our total J. Crew revenues.

 

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

 

J. Crew Direct’s circulationstrategy focuses on continually improving the segmentation of customer filesand the acquisition of additional customer names. In fiscal 2003, approximately65% of J. Crew Direct revenues

 

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

 

•              ourretail stores;

 

•              ourinternet website;

 

•              listrentals; and

 

•              exchangeswith other catalog companies.

 

We have installed telephones inall of our J. Crew Retail stores with direct access to the J. Crew Directtelemarketing center to allow customers in the stores to order catalog-specificor out-of-stock items.

 

All creative work on thecatalogs is coordinated by J. Crew personnel to maintain and reinforce the J.Crew brand image. Photography is executed both on location and in studios, andcreative design and copy writing are executed on a desktop publishing system.Digital images are transmitted directly to outside printers, thereby reducinglead times and improving reproduction quality. We believe that appropriate pagepresentation of our merchandise stimulates demand, and therefore we place greatemphasis on page layout.

 

J. Crew Direct does not havelong-term contracts with paper mills. Projected paper requirements arecommunicated on an annual basis to paper mills to ensure the availability of anadequate supply. Management believes that our long-standing relationships witha number of the largest coated paper mills in the United States allow us topurchase paper at favorable prices commensurate with the volume of ourpurchases.

 

In 1996, we launched ourinternet website located at www.jcrew.com, making J. Crew merchandise availableto our customers over the internet. In fiscal 2003, the website logged over38 million unique visitors and represents 65% of the J. Crew Directbusiness. We design and operate our website using an in-house technical staffand our website emphasizes simplicity and ease of customer use whileintegrating the J. Crew brand’s aspirational lifestyle imagery used in thecatalog.

 

***J. Crew Factory***

 

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

 

J. Crew Factory stores have anaverage size of 6,500 total square feet and are generally located in majorregional outlet centers in 24 states across the United States. We believe thatthe factory stores, which are designed in-house, maintain fixturing, visualpresentation and service standards comparable to those typically associatedwith outlet stores.

 

**Forward Looking Statements**

 

Certain statements in thisAnnual Report on Form 10-K/Aunder the captions “Business,” “Selected Financial Data,” “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”“Financial Statements and Supplementary Data” and elsewhere constitute“forward-looking statements” within the meaning of the Private SecuritiesLitigation Reform Act of 1995. We may also make written or oral forward lookingstatements in our periodic reports to the Securities and Exchange Commission onForms 10-Q, 8-K, etc., in press releases and other written materials and inoral statements made by our officers, directors or employees to third parties.Statements that are not historical facts, including statements about ourbeliefs and expectations, are forward-looking statements. Such forward-lookingstatements involve known and unknown risks, uncertainties and other importantfactors that could cause the actual results, performance or achievements of theCompany, or industry results, to differ materially from historical results, anyfuture results, performance or achievements expressed or implied by suchforward-looking statements. Such risks and uncertainties include, but are notlimited to, competitive pressures in the apparel industry, changes in levels ofconsumer spending or preferences in apparel and acceptance by customers of theCompany’s products, overall economic conditions, governmental regulations andtrade restrictions, acts of war or terrorism in the United States or worldwide,political or financial instability in the countries where the Company’s goodsare manufactured, postal rate increases, paper and printing costs, availabilityof suitable store locations at appropriate terms, the level of the Company’sindebtedness and exposure to interest rate fluctuations, and other risks anduncertainties described in this report and the Company’s other reports anddocuments filed or which may be filed, from time to time, with the Securitiesand Exchange Commission. These statements are based on current plans, estimatesand projections, and therefore you should not place undue reliance on them.Forward looking statements speak only as of the date they are made and weundertake no obligation to update publicly any of them in light of new informationor future events.

 

**Available Information**

 

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

 

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D.C. 20549, or by calling the SEC at(800) SEC-0330. In addition, the SEC maintains an internet site(www.sec.gov) that contains reports, proxy information statements and otherinformation regarding issuers that file electronically.

 

Our filings under the ExchangeAct (including annual reports on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K and all amendments to thesereports) are also available free of charge on our internet website atwww.jcrew.com. These reports are available as soon as reasonably practicableafter such material is electronically filed with or furnished to the SEC. Thereference to the Company’s website address does not constitute incorporation byreference of the information contained on the website, and the informationcontained on the website is not part of this document.

 

**ITEM 2.****          PROPERTIES**

 

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

 

As of January 31, 2004, weoperated 154 J. Crew retail stores and 42 factory stores in 38 states and theDistrict of Columbia. All of the retail and factory stores are leased fromthird parties, and the leases in most cases have terms of 10 to 12 years,with options to renew for periods typically ranging from five to ten years. Asa general matter, the leases contain standard provisions concerning the paymentof rent, events of default and the rights and obligations of each party. Rentdue under the leases is generally comprised of annual base rent plus a contingentrent payment based on the store’s sales in excess of a specified threshold.Some of the leases also contain early termination options, which can beexercised by us or in some cases the landlord under certain conditions. Theleases also generally require us to pay real estate taxes, insurance andcertain common area costs. Substantially all of the leases are guaranteed byus.

 

The table below sets forth thenumber of stores by state operated by us in the United States as ofJanuary 31, 2004.

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

 

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**ITEM 3.****          LEGAL PROCEEDINGS**

 

Charles E. Hill &Associates, Inc., or Hill, filed a lawsuit on August 16, 2002 in theU. S. District Court for the Eastern District of Texas against us and seventeenother defendants, primarily large retailers, alleging infringement of threepatents registered to Hill relating to electronic catalog systems and methodsfor processing data at a remote location and updating and displaying that data.The suit seeks an injunction against continuing infringement, unspecifieddamages, including treble damages for willful infringement, and interest,costs, expenses and fees. We believe that we have meritorious defenses andintend to defend ourselves vigorously.

 

In addition, we are subject tovarious legal proceedings and claims that arise in the ordinary conduct of ourbusiness. Although the outcome of these other claims cannot be predicted withcertainty, management does not believe that the ultimate resolution of thesematters will have a material adverse effect on our financial condition orresults of operations.

 

**ITEM 4.****          SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

No matters were submitted to avote of security holders during the quarter ended January 31, 2004.

 

**PART II**

 

**ITEM 5.****          MARKET FOR REGISTRANT’SCOMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

There is no established publictrading market for Group or Operating Corp. commonstock or for Intermediate’s equity. As of April 15, 2004, there were 44shareholders of record of the Group common stock. See “Item 12.Security Ownership of Certain Beneficial Owners and Management” for adiscussion of the ownership of Group. Group is the sole member ofIntermediate, and Intermediate owns 100% of the common stock of Operating Corp.

 

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

 

Our credit facility withWachovia Bank, N.A., as arranger, Congress Financial Corporation, asadministrative and collateral agent, and a syndicate of lenders (the “CongressCredit Facility”) and the Indenture relating to the 13 1¤8%senior discount debentures of Group (the “Group Indenture”) prohibit thepayment of dividends by Group on shares of common stock(other than dividends payable solely in shares of capital stock of Group). Additionally, because Group is a holding company, itsability to pay dividends is dependent upon the receipt of dividends from itsdirect and indirect subsidiaries. Each of the Congress Credit Facility, the Group Indenture and the Indenturerelating to the 10 3¤8%senior subordinated notes of Operating Corp., contains covenants which imposesubstantial restrictions on Operating Corp.’s ability to pay dividends or makedistributions to Group.

 

**Equity Compensation Plan Information**

 

The following table summarizesinformation about the Amended and Restated J. Crew Group, Inc. 1997 StockOption Plan and the J. Crew Group, Inc. 2003 Equity Incentive Plan (the“2003 Plan”), as of January 31, 2004. Our shareholders have approved bothof these plans.

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

 

In addition to options, the2003 Plan authorizes the issuance of restricted stock of Group. The 2003 Plan contains asub-limit of 1,450,724 shares on the aggregate number of shares of restricted Group common stock which may beissued, of which 1,144,979 shares are outstanding and 305,745 shares areavailable.

 

7

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**ITEM 6.****          SELECTED FINANCIAL DATA**

 

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

 
| ** **                                                                  | ** ** | **Fiscal Year Ended**                                   | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **January 29,  2000**                                   | ** ** | **February 3,  2001(a)** | ** ** | **February 2,  2002** | ** ** | **February 1,  2003** | ** ** | **January 31,  2004**

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

 

8

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----

 

(a)           The fiscal year 2000 consisted of53 weeks compared to 52 weeks in all other fiscal years. Net salesfor the fifty-third week increased fiscal 2000 sales by $10.8 million.

 

(b)           Includes buying and occupancy costs.

 

(c)           Amounts reported in prior periods foramortization of deferred landlord contributions have been reclassified fromdepreciation and amortization to rent expense to conform to currentpresentation.

 

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

 

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

 

(f)            Capital expenditures are net of proceedsfrom construction allowances.

 

(g)           Amounts previously reported forfiscal year ended January 31, 2004 have been restated. (See Note2 to the consolidatedfinancial statements for a description of therestatement).

 

9

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**ITEM 7.****          MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

This discussion summarizes the significant factors affecting ourconsolidated operating results, financial condition and liquidity during thethree-year period ended January 31, 2004. You should read the followingdiscussion and analysis in conjunction with our audited consolidated financialstatements for the three-year period ended January 31, 2004 and therelated notes thereto included herein.

 

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

 

**Management Overview**

 

The fashion and apparel industry is highly competitive. We competeprimarily with specialty brand retailers, department stores, massmerchandisers, other catalog operations, and internet businesses that engage inthe retail sale of men’s and women’s apparel, accessories, footwear and generalmerchandise. We believe that the principal bases upon which we compete arequality, design, efficient service, selection and price. We believe that our successdepends in substantial part on our ability to originate and define product andfashion trends as well as to anticipate, gauge and react to changing consumerdemands in a timely manner.

 

The industry in which we operate is cyclical. Purchases of apparel andrelated merchandise is sensitive to a number of factors that influence thelevels of consumer spending including economic conditions and the level ofdisposable consumer income, consumer debt, interest rates and consumerconfidence. The recent economic environment had a negative impact on our salesand contributed to a higher level of promotional sales activities whichadversely affected our profitability. We believe our comparable store salesresults in fiscal 2001 and 2002 also resulted from customer dissatisfactionwith our product offerings. When our new management took over inJanuary 2003, they initiated a program to upgrade the quality and style ofour merchandise assortments. These changes were not implemented until our Falland Holiday 2003 product offerings.

 

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

 

**Restatement**

 

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

 

**Results of Operations**

 

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

 
| ** **                                                         | ** ** | **Fiscal Year Ended**                     | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                         | ** ** | **January 31,  2004**

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

 

----

(1)           Includes licensing, shipping and handlingfees.

 

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

 

(3)           Amounts reported in prior periods foramortization of deferred landlord contributions have been reclassified fromdepreciation and amortization to rent expense to conform to current yearpresentation.

 

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

 

10

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**Revenues**

 

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

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

 

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

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

 

Net sales in 2003 were$408.1 million flat with fiscal 2002. A decline of 3.4% in comparablestore sales was offset by sales from four stores opened in fiscal 2003 and16 stores opened in 2002 that were open for a full year in fiscal 2003. Theimprovement in comparable store sales results in 2003 is the result of animproving economy and an upgrade in the quality and style of our merchandiseassortments in the second half of the year. The increase in net sales of 2.5% infiscal 2002 compared to fiscal 2001 was derived from the sales of 16 new storesopened during 2002 and the 34 stores opened in 2001 that were open for a fullyear in fiscal 2002, which offset a decline of 10.4% in comparable store sales.We believe this decrease in comparable store sales was attributable to theeffect of the continuing slow economy on consumer spending and customerdissatisfaction with our product offerings.

 

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

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

 

Net sales in the Directbusiness decreased from $248.0 million in 2002 to $173.5 million in2003, a decrease of 30%. This decrease resulted from (a) a 25% decrease incatalog circulation from 7.8 billion pages in 2002 to 5.8 billionpages in 2003 including the elimination of women’s only and clearance catalogsin the second half of the year (b) a decrease in density (items per page)resulting from a 30% reduction in style counts and (c) the reduction inpromotional practices, including promotional e-mails.

 

The decrease in net sales of 4%from $258.2 million in 2001 to $248.0 million in 2002 resulted from adecrease in catalog sales not offset by the increase in Internet sales. Pagescirculated decreased by 6% from 8.3 billion pages in 2001 to7.8 billion pages in 2002 while internet sales increased from the effortsto migrate customers to the Internet through promotional e-mails and otheractivities.

 

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

 

11

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

 

The increase in factory storesales in 2003 resulted from the increase in comparable store sales. Westrengthened our factory business in fiscal 2003 by moving away from deepdiscounting of prior season’s merchandise carried over from our Retail andDirect channels to having our factory channel create and sell its ownmerchandise. This change was effective in the 2003 Fall season and contributedto a 9% increase in comparable store sales in the Fall season. The decline infactory store sales in 2002 from 2001 resulted from higher markdowns to clear excessprior season inventories.

 

Other revenues for fiscal years2003, 2002 and 2001 were, as follows:

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

 

The decline in other revenuesduring the three year period resulted from a decrease in shipping and handlingfees which is directly attributable to the downward trend in net sales of theDirect business.

 

**Cost of sales,including buying and occupancy costs**

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

 

Thedecrease in gross margin from 2002 to 2003 resulted primarily from the180 basis point increase in buyingand occupancy costs (including the writeoff of certain prepaid samplecosts which increased buying andoccupancy costs by 40 basis points)as a percentage of revenues because of the decrease inrevenues not offset by a decrease in buying and occupancy costs which areprimarily fixed expenses and a decrease of 50 basis points in merchandisemargins primarily from the liquidation of prior season’s inventories in thefirst half of 2003.

 

The decrease in gross marginfrom 2002 to 2001 was caused by an increase of 120 basis points in buying andoccupancy costs as a percentage of revenues because of the decrease in revenuesnot offset by a decrease in buying and occupancy costs which are primarilyfixed expenses and a 180 basis point decrease in merchandise margins from themarkdowns taken to clear inventories in the fourth quarter of 2002. The fourthquarter of 2002 also included a $9 million charge as result of thedecision to modify our disposition strategy to accelerate inventory clearing atthe end of each selling season.

 

**Selling, general and administrative expenses**

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

 

12

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Selling expenses consist ofcatalog production and mailing costs. Pages circulated were 5.8 billion,7.8 billion and 8.3 billion in fiscal 2003, 2002 and 2001. Thedecreases in selling expenses during the period were related primarily to thereduction in pages circulated and the elimination of women’s only editions andclearance catalogs in the second half of 2003. A decrease in the cost of paperalso contributed to the decrease from 2001 to 2002.

 

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

 

The increase in general and administrativeexpenses in 2002 compared to 2001 resulted from (a) severance and otherone time employment related charges of $13.7 million and (b) storeexpenses related to the additional stores in operation in 2002 partially offsetby the cost reduction initiatives instituted in the first quarter of 2002.

 

**Interest Expense**

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

 

The change in interest expensefor Operating Corp. during the three year period related primarily to theincrease in amortization of deferred financing costs in fiscal 2002, whichresulted primarily from a write off of $1.8 million related to therefinancing of our working capital credit facility.

 

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

 

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

 

**Gain on exchange of debt**

 

The net consolidated gain onexchange of debt of $41.1 million reflects the difference between the fairvalue of the 16% senior discount notes at date of issuance and the carryingvalue of the 13 1¤8%senior discount

 

13

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

 

**Income Taxes**

 

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

 

The effective tax rate was abenefit of 9.4% in fiscal 2002 compared to a benefit of 33.3% in fiscal 2001.The lower effective rate in 2002 resulted from the establishment of a valuationallowance of $21.0 million to reduce the net deferred tax assets toestimated recoverable amount at February 1, 2003, offset by a benefit of$9.0 million from the reversal of prior years’ tax accruals. The valuationallowance was recorded in fiscal 2002 as a result of the significance of ournet loss in fiscal 2002 and management’s projection of taxable income/loss inthe near future. Management had previously concluded that considering allfactors, including available tax planning strategies and projections of futuretaxable income, it was more likely than not that the net deferred income taxassets would be realized. However, considering our substantially increasedlosses and declining trends and projections of operating losses in the nearfuture, the fact that our operating results for fiscal 2002 were significantlyworse than originally forecasted and the downward revision of the outlook forfiscal year 2003 and forward, we reassessed the need for a valuation allowance.We believed in fiscal 2002 that the “positive evidence” no longer outweighedthe “negative evidence” and a valuation allowance was, therefore, necessary.The tax accruals were reversed in 2002 based on a proposed IRS settlement ofopen years and results of state audits at amounts less than the accrued amounts.We do not expect to recognize any tax benefits in future results of operationsuntil an appropriate level of profitability is sustained.

 

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

 

**Insurance Proceeds**

 

Insurance proceeds in fiscal2002 and 2003 represent recoveries for claims related to the destruction of ourWorld Trade Center store on September 11, 2001. The recovery in fiscal2003 is the final settlement of this claim.

 

**Liquidity and Capital Resources**

 

Our sources of liquidity areprimarily cash flows from operations and borrowings under our working capitalcredit facility. Our primary cash needs are for capital expenditures incurredprimarily for opening new stores and system enhancements, debt servicerequirements and working capital.

 

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

 

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

 

The Congress Credit Facilitypermits restricted payments (by way of dividends or other distributions) withrespect to, among other things, our capital stock payable solely in additionalshares of our capital stock, our tax sharing agreement, the Series APreferred Stock of Group, the Series B PreferredStock of Group and the 13 1¤8%senior discount debentures due 2008 of Group. Our ability to declaredividends on our capital stock is also limited by Delaware law, which permits acompany to pay dividends on its capital stock only out of its surplus or, inthe event that it has no surplus, out of its net profits for the year in whicha dividend is declared or for the immediately preceding fiscal year. Under theCongress Credit Facility, the assets of Intermediate and its subsidiaries arerestricted.

 

Cash provided by operatingactivities was $16.2 million in fiscal 2003, $25.3 million in fiscal2002 and $25.8 million in fiscal 2001. The increases in net losses in 2003and 2002 were offset by improvements in working capital, primarily reductionsin inventories of $41.3 million in 2003 and $31.6 million in 2002.

 

Capital expenditures, net ofconstruction allowances were $7.9 million in fiscal 2003, $20.4 millionin fiscal 2002 and $42.6 million in 2001. Capital expenditures related tonew stores were $3.5 million, $11.4 million and $17.6 millionduring the three years. Furthermore, fiscal 2001 included software developmentcosts of

 

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

 

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

 

On May 6, 2003, we(through our wholly-owned subsidiary, Intermediate) completed an offer toexchange 16% senior discount contingent principal notes for the outstanding 131¤8%senior discount debentures of Group. Approximately 85% of theoutstanding senior discount debentures of Group were tendered for exchange.Effective October 15, 2002, the interest payments accruing on the seniordiscount debentures of Group became payable in cash onApril 15 and October 15 of each year subsequent thereto. We did notpay the accrued and unpaid interest on the senior discount debentures of Group on the scheduled interestpayment date of April 15, 2003. Rather, we paid such interest onMay 6, 2003, the settlement date of the exchange offer, together withinterest thereon at a rate of 13 1¤8%per annum from April 15, 2003 to May 5, 2003, to the holders of thesenior discount debentures of Group who did not tender theirdebentures for the initial notes in the exchange offer. Interest on the 16% notesbecomes payable in cash commencing on November 15, 2005 and is payable oneach May 15 and November 15 thereafter through May 15, 2008.

 

Management believes thatinvested cash, cash flow from operations and availability under the CongressCredit Facility will provide adequate funds for our foreseeable working capitalneeds, planned capital expenditures and debt service obligations. Our abilityto fund our operations and make planned capital expenditures, to make scheduleddebt payments, to refinance indebtedness and to remain in compliance with thefinancial covenants under our debt agreements depends on our future operatingperformance and cash flow, which in turn, are subject to prevailing economicconditions and to financial, business and other factors, some of which arebeyond our control.

 

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**Off Balance Sheet Arrangements**

 

We enter into letters of creditto facilitate the international purchase of merchandise. Standby letters ofcredit are required to secure certain obligations.

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

 

**Contractual Obligations**

 

The following summarizes ourcontractual obligations as of January 31, 2004 and the effect suchobligations are expected to have on our liquidity and cash flows in futureperiods.

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

 

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(1)           Excludes unamortized debt issuance discount.

 

(2)           Operating lease obligations representobligations under various long-term operating leases entered in the normalcourse of business for retail and factory stores, warehouses, office space andequipment requiring minimum annual rentals. Operating lease expense is asignificant component of our operating expenses. The lease terms range forvarious periods of time in various rental markets and are entered into atdifferent times, which mitigates exposure to market changes which could have amaterial effect on the company’s results of operations within any given year.

 

**Impact of Inflation**

 

Our results of operations andfinancial condition are presented based upon historical cost. While it isdifficult to accurately measure the impact of inflation due to the imprecisenature of the estimates required, we believe that the effects of inflation, ifany, on our results of operations and financial condition have been minor.However, there can be no assurance that during a period of significantinflation, our results of operations would not be adversely affected.

 

**Seasonality**

 

We experience two distinctselling seasons, spring and fall. The spring season is comprised of the firstand second quarters and the fall season is comprised of the third and fourthquarters. Net sales are usually substantially higher in the fall season andselling, general and administrative expenses as a percentage of net sales areusually higher in the spring season. Approximately 31% of annual net sales infiscal 2003 occurred in the fourth quarter. Our working capital requirementsalso fluctuate throughout the year, increasing substantially in September andOctober in anticipation of the holiday season inventory requirements.

 

**Recent Accounting Pronouncements**

 

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

 

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In May 2003, the FASB issued **SFASNo. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.”** This statementestablishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities and equity. Itrequires that an issuer classify a financial instrument that is within itsscope as a liability (or an asset in some circumstances). Many of thoseinstruments were previously classified as equity. The provisions of thisstatement were effective at the beginning of the first interim period beginningafter June 15, 2003. The adoption of SFAS No. 150 resulted in areclassification of the liquidation value and accumulated and unpaid dividendsof the Series B preferred stock and the accumulated and unpaid dividendsrelated to the Series A preferred stock to liabilities, which totaled$211.7 million as of January 31, 2004. After such reclassification,the dividends related to the Series B preferred stock and the accreteddividends of the Series A Preferred Stock will be treated as interestexpense.

 

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

 

**Critical Accounting Policies**

 

Management’s discussion and analysis of financial condition and resultsof operations is based upon the consolidated financial statements which havebeen prepared in accordance with accounting principles generally accepted inthe United States. The preparation of these financial statements requiresestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses. We base our estimates on historicalexperience and other assumptions that are believed to be reasonable under the circumstancesand evaluate these estimates on an on-going basis. Actual results may differfrom these estimates under different assumptions or conditions.

 

The following critical accounting policies, which we have discussedwith our audit committee, reflect the more significant estimates and judgmentsused in the preparation of our consolidated financial statements. We do notbelieve that changes in these assumptions and estimates are likely to have amaterial impact on our consolidated financial statements.

 

***Inventory Valuation***

 

Merchandise inventories are carried at the lower of cost or market. Weevaluate all of our inventories to determine excess inventories based onestimated future sales. Excess inventories may be disposed of through factory,clearance catalogs, internet clearance sales and other liquidations. Based onhistorical results experienced through various methods of disposition, we writedown the carrying value of inventories that are not expected to be sold at orabove costs.

 

***Deferred CatalogCosts***

 

The costs associated with direct response advertising, which consistprimarily of catalog production and mailing costs, are capitalized andamortized over the expected future revenue stream of the catalog mailings,which approximates four months. The expected future revenue stream isdetermined based on historical revenue trends developed over an extended periodof time. If the current revenue streams were to diverge from the expectedtrend, our future revenue streams would be adjusted accordingly.

 

***Asset Impairment***

 

We are exposed to potential impairment if the book value of our assetsexceeds their future cash flows. The major components of our long-lived assetsare store fixtures, equipment and leasehold improvements. The impairment ofunamortized costs is measured at the store level and the unamortized cost isreduced to fair value if it is determined that the sum of expected future netcash flows is less than net book value.

 

***Sales Returns***

 

We must make estimates of future sales returns related to currentperiod sales. Management analyzes historical returns, current economic trendsand changes in customer acceptance of our products when evaluating the adequacyof the reserve for sales returns.

 

***Income Taxes***

 

We have significant deferred tax assets resulting from net operatingloss carryforwards and deductible temporary differences, which will reducetaxable income in future periods. Statement of Financial Accounting Standards(“SFAS”) No. 109, “Accounting for Income Taxes” states that a valuation allowanceis required when it is more likely than not that all or a portion of a deferredtax asset will not be realized. A review of all available positive and negativeevidence needs to be considered, including a company’s current and pastperformance, the market environment in which a company operates, length ofcarryback and carryforward periods, existing contracts or sales backlog thatwill result in future profits, etc. Forming a conclusion that a valuationallowance is not needed is difficult when there is negative evidence such ascumulative losses in recent years. Cumulative losses weigh heavily in theoverall assessment. As a result of our assessments, we established a valuationallowance to reduce our net deferred tax assets to their estimated realizablevalue of $5.0 million at February 1, 2003 and we provided an

 

17

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additionalallowance at January 31, 2004 to fully reserve our net deferred taxassets. We do not expect to recognize any tax benefit in future results ofoperations until an appropriate level of profitability is sustained.

 

**ITEM 7A.****       QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Our principal market riskrelates to interest rate sensitivity, which is the risk that future changes ininterest rates will reduce our net income or net assets. Our variable rate debtconsists of borrowings under the Congress Credit Facility. The interest ratesare a function of the bank prime rate or LIBOR. A one percentage point increasein the base interest rate would result in approximately $100,000 change inincome before taxes for each $10 million of borrowings.

 

We have a licensing agreementin Japan which provides for royalty payments based on sales of J. Crewmerchandise as denominated in yen. We have entered into forward foreignexchange contracts from time to time in order to minimize this risk. AtJanuary 31, 2004, there were no forward foreign exchange contractsoutstanding.

 

We enter into letters of creditto facilitate the international purchase of merchandise. The letters of creditare primarily denominated in U.S. dollars. Outstanding letters of credit atJanuary 31, 2004 were $39.5 million, including $3.5 million ofstandby letters of credit.

 

**ITEM 8.****          FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

The Financial Statements areset forth herein commencing on page F-1 of this Report.

 

**ITEM 9.****          CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A.****       CONTROLS AND PROCEDURES**

 

(a)   *Evaluation of DisclosureControl**s andProcedures.*   Whenthe original Form 10-K was filed, we concluded that our disclosurecontrols and procedures as of the end of the period covered by the report wereeffective. Subsequent to the originalForm 10-Kfiling, in September 2004 our new Chief Financial Officer identified an errorin the company's accounting for samples in the course of reviewing thecompany's accounts upon joining the Company. As a result, we concluded that ourpreviously reported financial statements for the fiscal year endedJanuary 31, 2004 and for the first quarter ended May 1, 2004 shouldbe restated to reflect the write-off of certain prepaid samples incurred duringthose periods which should have been expensed as incurred. See Note 2 toour consolidated financial statements for a description of the restatement. We believe that the deficiencies in our disclosurecontrols and procedures that led to this error related to a lack of adequateresources to review ouraccounting policies as appropriate. We now have such adequate resources and webelieve that the deficiencies havebeen remediated. We continue to monitor the effectiveness of our disclosurecontrols and procedures on an ongoing basis.

 

(b)   *Changes in InternalControls.*   Therewere no significant changes in our internal controls over financial reportingduring the period covered by this report that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

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**PART III**

 

Information required by items10 - 14 with respect to Operating Corp. and Intermediate have beenomitted pursuant to General Instruction I of Form 10-K. Informationrequired by items 10 -14 with respect to Group is described below.

 

**ITEM 10.****                      DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

The following table sets forththe name, age and position of individuals who are serving as directors andexecutive officers of Group as of April 1, 2004.

 
| **Name**           | ** ** | **Age** | ** ** | **Position**                                                        |
|--------------------|------------|---------|------------|---------------------------------------------------------------------|
|               |       |    |       |                                                                |
| Millard  Drexler   |       | 59      |       | Chief  Executive Officer, Chairman of the Board and Director        |
| Jeffrey  Pfeifle   |       | 45      |       | President                                                           |
| Roxane  Al-Fayez   |       | 47      |       | Executive  Vice President, Catalog & e-Commerce                 |
| Michael  Dadario   |       | 45      |       | Executive  Vice President, Stores                                   |
| Tracy  Gardner     |       | 39      |       | Executive  Vice President, Merchandising, Planning & Production |
| Paul Fusco         |       | 55      |       | Senior Vice  President, Chief Information Officer                   |
| Scott Hyatt        |       | 46      |       | Senior Vice  President, Manufacturing                               |
| Nicholas  Lamberti |       | 61      |       | Vice  President, Corporate Controller                               |
| Richard  Boyce     |       | 49      |       | Director                                                            |
| Jonathan  Coslet   |       | 39      |       | Director                                                            |
| James  Coulter     |       | 44      |       | Director                                                            |
| Steven  Grand-Jean |       | 61      |       | Director                                                            |
| Thomas Scott       |       | 38      |       | Director                                                            |
| Stuart Sloan       |       | 60      |       | Director                                                            |
| Josh Weston        |       | 75      |       | Director                                                            |
| Emily Woods        |       | 42      |       | Director                                                            |

 

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(1)                                  Amanda Bokmanwas also recently hired as Executive Vice President and Chief FinancialOfficer, effective on May 10, 2004.

 

 *MillardDrexler.*  Mr. Drexlerbecame Chief Executive Officer in January 2003 and Chairman of the Boardand Director in March 2003. Before joining Group, Mr. Drexler wasChief Executive Officer of The Gap, Inc. from 1995 untilSeptember 2002, and prior thereto he was President of The Gap, Inc.since 1987. Mr. Drexler also serves on the Board of Directors of AppleComputer Inc.

 

 *JeffreyPfeifle.*  Mr. Pfeiflebecame President in February 2003. Before joining Group, Mr. Pfeiflewas Executive Vice President, Product and Design of the Old Navy division ofThe Gap, Inc. from 1995.

 

 *RoxaneAl-Fayez.*  Ms. Al-Fayezbecame Executive Vice President, Catalog & e-Commerce inOctober 2003. Before joining Group, she was Vice President of Operations,Gap, Inc. Direct for six years.

 

 *MichaelDadario.*  Mr. Dadariobecame Executive Vice President, Stores in January 2003. Before joiningGroup, Mr. Dadario was a retail consultant with Sense Consulting fromFebruary 2000 until the end of 2002 and Executive Vice President (retailstore operations) of the Banana Republic division of The Gap, Inc. formore than five years.

 

 *TracyGardner.*  Ms. Gardnerbecame Executive Vice President, Merchandise, Planning & Production inMarch 2004. Prior to joining Group, Ms. Gardner held variouspositions at The Gap, Inc., including Senior Vice President of AdultMerchandising for GAP brand from 2002 to March 2004, Vice-President ofWomens’ Merchandising for the Banana Republic division from 2001 to 2002,Vice-President of Mens’ Merchandising for the Banana Republic division from1999 to 2001, and Divisional Merchandising Manager of Mens’ Wovens for theBanana Republic division prior to 1999.

 

 *Paul Fusco.*  Mr. Fusco has been Senior VicePresident, Chief Information Officer since 2000 and prior to that he was VicePresident—Application Development from 1999. Before joining Group,Mr. Fusco was Vice President—Client Relationship Executive for EnterpriseApplications of Metropolitan Life Insurance Company from 1996.

 

 *ScottHyatt.*  Mr. Hyatt hasbeen Senior Vice President, Manufacturing since 1998. Before joining Group,Mr. Hyatt was Vice President, Production and Sourcing of the Expressdivision of Limited Brands, a retail apparel company, from 1996 to 1998.

 

 *NicholasLamberti.*  Mr. Lambertihas been Vice President, Corporate Controller for more than five years.Effective August 22, 2003, Mr. Lamberti became acting Chief FinancialOfficer and will continue to serve in such role until Ms. Bokman commencesemployment on May 10, 2004.

 

 *RichardBoyce.*  Mr. Boyce hasbeen a Director since 1997 and has periodically served as Chief ExecutiveOfficer between 1997 and 1999 while also providing operating oversight to theremainder of the Texas Pacific Group portfolio. Mr. Boyce is a SeniorOperating Partner of Texas Pacific Group and joined Texas Pacific Group in1997.

 

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He served asChairman of Favorite Brands International Holding Corp., which filed forprotection under Chapter 11 of the Bankruptcy Code in 1999. Mr. Boyce isalso the Chairman of the Board of Directors of Burger King Corporation and aDirector of ON Semiconductor Corporation, Spirit Group Group, Ltd. and KratonPolymers.

 

 *JonathanCoslet.*  Mr. Cosletbecame a Director in 2003. Mr. Coslet is a senior Partner of Texas PacificGroup and is responsible for the investment firm’s generalist and healthcareinvestment activities. Prior to joining Texas Pacific Group, Mr. Cosletworked in the investment banking department of Donaldson, Lufkin &Jenrette, specializing in leveraged acquisitions and high yield finance from1991 to 1993. Mr. Coslet also serves on the Board of Directors of BurgerKing Corporation, Endurance Specialty Group Ltd., Oxford HealthPlans, Inc., Petco Animal Supplies, Inc. and Quintiles TransnationalCorp.

 

 *JamesCoulter.*  Mr. Coulter hasbeen a Director since 1997. Mr. Coulter is a founding Partner of TexasPacific Group, and has been Managing General Partner of Texas Pacific Group formore than eight years. Mr. Coulter also serves on the Board of Directorsof Conexant Systems, Inc., Seagate Technology, Inc. and ZhoneTechnologies.

 

 *StevenGrand-Jean.* Mr. Grand-Jean became a Director in 2003. Mr. Grand-Jean hasbeen President of Grand-Jean Capital Management for more than five years.

 

 *ThomasScott.*  Mr. Scott hasbeen a Director since 2002. Mr. Scott is a founding partner of Plum TV, atelevision station network in select resort markets, and served as its ChiefExecutive Officer and Executive Co-Chairman since September 2003. He isalso a founding partner of Nantucket Allserve Inc., a beverage supplier,and has served as Co-Chairman thereof since 1989 and Co-Chairman and Co-ChiefExecutive Officer from 1989 to 2000. Mr. Scott has also served asCo-Chairman of Shelflink, a supply chain software company, since 2000.Mr. Scott is married to Emily Woods, a Director of Group.

 

 *StuartSloan.*  Mr. Sloan hasbeen a Director since September 2003. Mr. Sloan is the founder ofSloan Capital Companies, a private investment company, and has been a Principalthereof since 1984. Mr. Sloan also serves on the Board of Directors ofAnixter International, Inc. and Rite Aid Corp.

 

 *JoshWeston.*  Mr. Weston hasbeen a Director since 1998. Mr. Weston has also served as HonoraryChairman of the Board of Directors of Automatic Data Processing, a computingservices business, since 1998. Mr. Weston was Chairman of the Board ofAutomatic Data Processing from 1996 until 1998, and Chairman and ChiefExecutive Officer for more than five years prior thereto. Mr. Weston alsoserves on the Board of Directors of Gentiva Health Services, Inc., AegisCommunications Group, Inc. and Russ Berrie & Company, Inc.

 

 *EmilyWoods.*  Ms. Woods hasserved as Chairman of the Board of Directors of Group since 1997 and resignedfrom this position in March 2003, although she continues to serve as aDirector. Ms. Woods started work at J. Crew the year that it was foundedin 1983 and has served as Chief Executive Officer from 1997 to 2000 and ViceChairman of Group prior thereto. Ms. Woods is married to Thomas Scott, aDirector of Group.

 

**Our Board of Directors**

 

Our Board of Directorscurrently has 9 members. Directors serve until the next annual meeting of shareholdersor until his or her successor has been elected and qualified. Directors may beremoved at any time, with or without cause, by vote of our shareholders. Ourboard of directors currently has two standing committees—an Audit Committee anda Compensation Committee.

 

***Audit Committee.***  The primary duties of the Audit Committeeinclude assisting the Board of Directors in its oversight of (i) theintegrity of the Company’s financial statements and financial reportingprocess; (ii) the integrity of the company’s internal controls regardingfinance, accounting and legal compliance; and (iii) the independence andperformance of the company’s independent auditors and internal audit function.The Committee also reviews our critical accounting policies, our annual andquarterly reports on Form 10-K and Form 10-Q, and our earningsreleases before they are published. The Committee has sole authority to engage,evaluate and replace the independent auditor. The Committee also has theauthority to retain special legal, accounting and other consultants it deemsnecessary in the performance of its duties. The Committee meets regularly withour management, independent auditors and internal auditors to discuss ourinternal controls and financial reporting process and also meets regularly withthe independent auditors and internal auditors in private.

 

The current members of theAudit Committee are Messrs. Boyce, Grand-Jean and Weston (Chairperson).The Board of Directors has determined that Josh Weston qualifies as an “audit committeefinancial expert” and is independent under the applicable rules of theSecurities and Exchange Commission.

 

***CompensationCommittee.*** The primary duty of the Compensation Committee is to discharge theresponsibilities of the Board of Directors relating to compensation practicesfor the company’s executive officers and other key employees, as the Committeemay determine, to ensure that management’s interests are aligned with theinterests of company’s equity holders. The Committee also review and makesrecommendations to the Board of Directors with respect to the company’semployee benefits plans, compensation and equity based plans and compensationof Directors. The current members of the Compensation Committee areMessrs. Coulter (Chairperson) and Sloan and Ms. Woods.

 

***Compensation ofDirectors.*** Directors who are employees or representatives of Texas Pacific Group donot receive any compensation for their services. In fiscal 2003, all otherDirectors received a non-qualified stock option to purchase 5,000 shares ofGroup common stock as compensation for their services. These options have anexercise price equal to $6.82 per share, have a term of 10 years andbecome exercisable and vest in equal annual installments over a four yearperiod. If a Director ceases to serve as a Director for any reason, other thanremoval for cause, any options vested at the time of the termination of his orher services will remain exercisable for 90 days (but not longer than the10 year term of the options).

 

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**Code of Ethics and Business Practices**

 

We have a Code of Ethics andBusiness Practices that applies to all of our directors and employees,including to our chief executive officer, chief financial officer, controllerand our other senior financial officers. A copy of the Code is filed as anexhibit to this Annual Report on Form 10-K and is available free of chargeupon written request to the Corporate Secretary, J.Crew Group, Inc., 770Broadway, New York, NY 10003.

 

**ITEM 11.****                      EXECUTIVECOMPENSATION**

 

The following table sets forthcompensation paid by Group for fiscal 2003, 2002 and 2001:

 

•                                          toour chief executive officer during fiscal 2003;

 

•                                          toeach of the four other most highly compensated executive officers as of the endof fiscal 2003; and

 

•                                          totwo additional executive officers who were not employed as of the end of fiscal2003.

 
| ** **                                                                             | ** ** | ** **       | ** ** | ** **                | ** ** | ** **              | ** ** | ** **             | ** ** | ** **                           | ** ** | **Long-Term  Compensation**                                | ** ** | ** **             | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------|------------|---------------------------|------------|-------------------------|------------|------------------------|------------|--------------------------------------|------------|------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                             | ** ** | ** **       | ** ** | ** **                | ** ** | ** **              | ** ** | **Awards**             | ** ** | ** **                           | ** ** | **Payouts**                                                | ** ** | ** **             | ** ** |
| **Name And Principal  Position**                                                       | ** ** | **Fiscal  Year** | ** ** | ** **                | ** ** | ** **              | ** ** | **Other  ($)**         | ** ** | **Restricted  Stock  Award(s)  (1)** | ** ** | **Numbers of  Securities   Underlying  Options/  SARS(1)** | ** ** | **LTIP  Payouts  ($)** | ** ** | **All Other  Compensation  ($)(2)** | ** ** |
| **Annual  Compensation**                                                               |
| **Salary  ($)**                                                                        | ** ** | **Bonus  ($)**   |
|                                                                                   |       |             |       |                      |       |                    |       |                   |       |                                 |       |                                                       |       |                   |       |   |   |
| Millard Drexler   Chief Executive Officer and   Chairman                     |       | 2003  2002       |       | 200,000    —         |       | —  —          |       | 500,000  —        | (3)        |                                 | (4)  (5)   | —    2,231,704                                        | (11)       | — —     |       | —    — |   |
| Jeffrey Pfeifle  President                                                             |       | 2003  2002       |       | 760,000  —           |       | 2,400,000  —       | (6)        | —  —         |       | —                               | (7)        | —  390,548                                            | (11)       | 400,000  —        |       | —  — |   |
| Kathy Boyer(8)  Former Executive   Vice-President,   Merchandising |       | 2003  2002       |       | 370,308  218,700          |       | —  —          |       | —  —         |       | —  —                       |       | —  35,000                                             |       | —  —         |       | 223,700  42,600 |   |
| Michael Dadario  Executive Vice-President,   Stores                          |       | 2003  2002       |       | 425,000  96,400           |       | 25,000  25,000          |       | —  —         |       | —  —                       |       | —  50,000                                             |       | —  —         |       | 37,900  — |   |
| Paul Fusco  Senior Vice President,   Chief Information Officer               |       | 2003  2002  2001 |       | 265,000  265,000  245,800 |       | —  —  126,000 |       | —  —  — |       | —  —  —               |       | 15,000  —  15,000                                     |       | —  —  — |       | 9,300  9,100  5,250 |   |
| Scott Hyatt  Senior Vice President,   Manufacturing                          |       | 2003  2002  2001 |       | 364,000  364,000  353,200 |       | —  —  183,800 |       | —  —  — |       | —  —  —               |       | —  —  10,000                                     |       | —  —  — |       | 10,500  9,700  5,250 |   |
| Scott Gilbertson(9)  Former Chief Operating   Officer                        |       | 2003  2002       |       | 450,000  —           |       | 250,000  —         |       | —  —         |       | —                               | (10)       | —  245,487                                            |       | —  —         |       | 717,400  — |   |

 

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(1)                                  There is noestablished public market for shares of Group common stock. Holders ofrestricted stock have the same right to receive dividends as other holders ofGroup common stock. Group has not paid any cash dividends on its common stock.

 

As of January 31, 2004, the named executive officers held thefollowing aggregate number of restricted shares of Group common stock:Mr. Drexler—262,523 vested shares (of which 55,793 shares are held by acorporation of which Mr. Drexler is a principal) and 602,262 unvestedshares; Mr. Pfeifle—40,449 vested shares and 121,349 unvested shares;Mr. Gilbertson—27,896 vested shares and no unvested shares.

 

(2)                                  For Ms. Boyer,this includes $207,500 in severance compensation payable pursuant to herseparation agreement and $16,200 and $42,600 in relocation compensation infiscal 2003 and fiscal 2002, respectively.

 

For Mr. Dadario, this includes $36,900 in relocation compensationin fiscal 2003.

 

For Mr. Gilbertson, this includes (i) $675,000 in severancecompensation payable pursuant to his separation agreement and (ii) $42,400in relocation compensation in fiscal 2003.

 

We refer you to “Employment Agreements and Other CompensationArrangements—Separation Agreements” for a description of Ms. Boyer’s andMr. Gilbertson’s separation agreements.

 

All other amounts represent contributions made by Group on behalf ofthe named executive officers to

 

21

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its 401(k) plan.

 

(3)                                  This amountrepresents the reimbursement of certain business expenses to Mr. Drexlerin fiscal 2003 in accordance with the terms of his services agreement.

 

(4)                                  Mr. Drexler wasgranted 83,689 shares of Group common stock in September 2003, of which5,976 shares vested immediately upon grant, 19,428 shares vested onJanuary 27, 2004 and the remainder will vest in equal annual installmentson January 27, 2005, 2006 and 2007.

 

(5)                                  Mr. Drexler wasgranted 725,303 shares of Group common stock in February 2003, of which181,326 shares vested on January 27, 2004 and the remainder will vest inequal annual installments on January 27, 2005, 2006 and 2007.Mr. Drexler paid $800,000 to Group for these shares, which was in excessof their fair market value at the time of grant. A corporation of whichMr. Drexler is a principal was also granted 55,793 shares of Group commonstock, all of which vested immediately upon grant.

 

(6)                                  This amountrepresents a $2,000,000 sign-on bonus and a $400,000 guaranteed annual bonusfor fiscal 2003.

 

(7)                                  Mr. Pfeifle wasgranted 111,585 shares of Group common stock in February 2003, of which27,896 shares vested on February 1, 2004 and the remainder will vest inequal annual installments on February 1, 2005, 2006 and 2007.Mr. Pfeifle was also granted 50,213 shares of Group common stock inSeptember 2003, of which 12,553 shares vested on February 1, 2004 andthe remainder will vest in equal annual installments on February 1, 2005,2006 and 2007.

 

(8)                                  Ms. Boyer’semployment terminated in January 2004. We refer you to “EmploymentAgreements and Other Compensation Arrangements—Separation Agreements” for adescription of Ms. Boyer’s separation agreement.

 

(9)                                  Mr. Gilbertson’semployment began in January 2003 and terminated in January 2004. Werefer you to “Employment Agreements and Other CompensationArrangements—Separation Agreements” for a description of Mr. Gilbertson’sseparation agreement.

 

(10)                            Mr. Gilbertson wasgranted 111,585 shares of Group common stock in January 2003, which wereto vest in equal annual installments on January 27, 2004, 2005, 2006 and2007. As a result of the termination of Mr. Gilbertson’s employment,27,896 of these restricted shares vested and the remainder of them wereforfeited immediately in accordance with the terms of his separation agreement.

 

(11)                            Messrs. Drexler andPfeifle surrendered a portion of these options to Group in September 2003.In consideration of the surrender, we agreed to grant replacement options toMessrs. Drexler and Pfeifle following a six month period at exerciseprices not less than fair market value on the date of grant. We refer you to“Employment Agreements and Other Compensation Arrangements—EmploymentAgreements” for information on this agreement.

 

***Option Grants inLast Fiscal Year***

 

The following table shows information concerning stock options topurchase shares of Group common stock granted to any of the named executiveofficers during fiscal 2003.

 

 
| ** **                                     | ** ** | ** **                                              | ** ** | **Potential Realizable  Value at Assumed  Annual Rates of  Stock Price  Appreciation for  Option Term(2)** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|
| **Individual Grants**                          |
| **Number of  Securities  Underlying  Options** | ** ** | **Percent of  Total Options  Granted to  Employees in** | ** ** | **Exercise**                                                                                               | ** ** | **Expiration** |
| **Name**                                       | ** ** | **Granted(1)**                                          | ** ** | **Fiscal Year**                                                                                            | ** ** | **Price($/Sh)** | ** ** | **Date** | ** ** | **5%($)** | ** ** | **10%($)** | ** ** |
|                                           |       |                                                    |       |                                                                                                       |       |   |   |   |   |   |   |   |   |
| Millard Drexler                                |       | 557,926  836,889  836,889                               | (3)  (3)   | 47  82  82                                                                                                 | %  %  %    | $  $  $ | 6.82  25.00  35.00 |   | 2013  2013  2013 |   | 0  0  0 | (2)  (2)  (2) | 0  0  0 | (2)  (2)  (2) |
| Scott Gilbertson(4)                            |       | 111,585  66,951  66,951                                 |       | 9  7  7                                                                                                    | %%  %      | $  $  $ | 6.82  25.00  35.00 |   | 2013  2013  2013 |   | 0  0  0 | (2)  (2)  (2) | 0  0  0 | (2)  (2)  (2) |
| Jeffrey Pfeifle(3)                             |       | 167,378  111,585  111,585                               | (3)  (3)   | 14  11  11                                                                                                 | %  %  %    | $  $  $ | 6.82  25.00  35.00 |   | 2013  2013  2013 |   | 0  0  0 | (2)  (2)  (2) | 0  0  0 | (2)  (2)  (2) |
| Paul Fusco                                     |       | 15,000                                                  |       | 1                                                                                                          | %          | $ | 6.82 |   | 2013 |   | 0 | (2) | 0 | (2) |

 

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(1)                                  Group has not grantedany SARs.

 

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(2)                                  There is noestablished public market for shares of Group’ common stock. Based on customarycorporate valuation techniques, including an analysis of the discounted valueof Group’ potential earnings and cash flow, the valuation of comparablecompanies and current book value per share, the value of a share of Group’common stock was estimated to be less than $1 as of January 1, 2003. TheCompany believes that this value is still appropriate as of January 31,2004. As such, all outstanding options had exercise prices that exceeded thevalue of the stock as of such date, and the potential realizable value andvalue of unexercised in-the-money options is shown as zero.

 

(3)                                  We refer you tofootnote 11 to the Executive Compensation Table for information onMessrs. Drexler and Pfeifle’s surrender of these options in September2003.

 

(4)                                  Mr. Gilbertson’semployment terminated in January 2004, as a result of which a portion ofthese options vested and the remainder were forfeited automatically. We referyou to “Employment Agreements and Other Compensation Arrangements—SeparationAgreements” for information on Mr. Gilbertson’s separation agreement.

 

***Aggregated OptionExercises in Last Fiscal Year and Fiscal Year End Option Values***

 

The following table shows the number of stock options held to purchaseshares of Group common stock by the named executive officers of Group at theend of fiscal 2003. The named executive officers did not exercise any stockoptions in fiscal 2003.

 
| **Name**            | ** ** | **Shares Acquired on  Exercise(#)** | ** ** | **Value Realized(#)** | ** ** | **Number of Securities Underlying  Unexercised Options at Fiscal  Year End  Exercisable/Unexercisable** | ** ** | **Value of Unexercised  In-the-Money Options at  Fiscal Year End($)(1)  Exercisable/Unexercisable** | ** ** |
|---------------------|------------|-------------------------------------|------------|-----------------------|------------|---------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
|                |       |                                |       |                  |       |                                                                                                    |       |                                                                                                |       |
| Millard Drexler(2)  |       | 0                                   |       |                  |       | 0/557,926                                                                                               |       | 0/0                                                                                                 |       |
| Jeffrey Pfeifle(2)  |       | 0                                   |       |                  |       | 0/167,378                                                                                               |       | 0/0                                                                                                 |       |
| Kathy Boyer(3)      |       | 0                                   |       |                  |       | 7,000/0                                                                                                 |       | 0/0                                                                                                 |       |
| Michael Dadario     |       | 0                                   |       |                  |       | 10,000/40,000                                                                                           |       | 0/0                                                                                                 |       |
| Paul Fusco          |       | 0                                   |       |                  |       | 16,600/28,400                                                                                           |       | 0/0                                                                                                 |       |
| Scott Gilbertson(4) |       | 0                                   |       |                  |       | 114,372/0                                                                                               |       | 0/0                                                                                                 |       |
| Scott Hyatt         |       | 0                                   |       |                  |       | 29,000/6,000                                                                                            |       | 0/0                                                                                                 |       |

 

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(1)                                  There is noestablished public market for shares of Group common stock. Based on customarycorporate valuation techniques, including an analysis of the discounted valueof Group’ potential earnings and cash flow, the valuation of comparablecompanies and current book value per share, the value of a share of Group’common stock was estimated to be less than $1 as of January 1, 2003. TheCompany believes that this value is still appropriate as of January 31, 2004.As such, all outstanding options had exercise prices that exceeded the value ofthe stock as of such date, and the potential realizable value and value ofunexercised in-the-money options is shown as zero.

 

(2)                                  We refer you tofootnote 11 to the Executive Compensation Table for information on thesurrender by Messrs. Drexler and Pfeifle of a portion of their options inSeptember 2003.

 

(3)                                  Ms. Boyer’semployment terminated in January 2004, as a result of which these optionshave been forfeited in accordance with the terms of our stock option plan.

 

(4)                                  Mr. Gilbertson’semployment terminated in January 2004, as a result of which all of hisunvested options have been forfeited in accordance with the terms of our stockoption plan.

 

***LongTerm Incentive Plan***

 

The following table shows the eligibility of our President to receivelong-term incentive compensation pursuant to our employment agreement with him.At the end of fiscal 2003, Mr. Pfeifle received a payment equal to$400,000 under this arrangement. We refer you to “Employment Agreements andOther Compensation Arrangements—Employment Agreements” for information on thepayout schedule.

 

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**Long Term Incentive Plan/Awards in LastFiscal Year**

 
| **Name**                                                        | ** ** | **Number  of Shares,  Units or  Other  Rights(#)** | ** ** | **Performance  or Other  Period Until  Maturation or  Payout** | ** **      | ** ** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------------------|-----------------|------------|------------|
| ** **                                                      |
| **Estimated Future Payouts under  Non-Stock-Price-Based Plans** |
| **Threshold  ($ or #)**                                    | ** ** | **Target  ($ or #)**                          | ** ** | **Maximum  ($ or #)**                                     |
|                                                            |       |                                               |       |                                                           |            |       |       |   |   |   |   |
| Jeffrey Pfeifle                                                 |       | $                                                  | 400,000    |                                                           | 1/31/03-4/30/05 |       | $          | 800,000 |   | $ | 1,000,000 |   | $ | 1,200,000 |   |
|                                                                 |            |                                                    |            |                                                                |                 |            |            |  |  |  |  |  |  |  |  |

 

 

**Employment Agreements and Other CompensationArrangements**

 

**Employment Agreements**

 

 *MillardDrexler.*  Mr. Drexler hasa services agreement with the Company pursuant to which he will serve as ChiefExecutive Officer for five years beginning on January 27, 2003, providedthat Mr. Drexler can step down as Chief Executive Officer afterJanuary 2006 and serve only as Executive Chairman. The agreement providesfor a minimum annual base salary of $200,000, an annual bonus based on theachievement of earnings objectives to be determined each year, andreimbursement of business expenses, provided that such total compensation notexceed $700,000 per year. The agreement also provides for (i) the grant ofoptions to purchase 557,926 shares of Group common stock at an exercise priceequal to $6.82 per share, which we refer to as initial options, and(ii) the grant of premium options to purchase an additional 836,889 sharesat an exercise price equal to $25.00 per share and 836,889 shares at anexercise price equal to $35.00 per share, which we refer to as premium options.The initial options and the premium options vest in equal annual installmentsover four years commencing on the second anniversary of the grant date. Theagreement also provides for the grant of 55,793 immediately vested shares ofGroup common stock and the grant of 725,303 shares of Group common stock, whichwe refer to as the “Drexler Restricted Shares.” Mr. Drexler paid Group$200,000 for the initial options and $800,000 for the Drexler RestrictedShares.

 

Pursuant to the agreement, if Mr. Drexler’s employment isterminated without “cause” or for “good reason” (each as defined in theservices agreement), Mr. Drexler will be entitled to receive his basesalary for one year, the immediate vesting of any unvested Drexler RestrictedShares and the immediate vesting of that portion of the initial options and thepremium options that would have become vested and exercisable on theanniversary of the grant date immediately following the termination date. Ifsuch termination occurs after a “change in control” (as defined in the servicesagreement), all of the unvested initial options and premium options willimmediately vest and become exercisable.

 

In September 2003, Mr. Drexler received an additional grantof 83,689 Drexler Restricted Shares, of which 5,976 shares vested immediatelyand the remainder vest over time. Mr. Drexler also surrendered all of hispremium options to Group in September 2003. In consideration of thesurrender, we agreed to grant to Mr. Drexler replacement premium optionsfollowing a six month period at exercise prices not less than fair market valueon the date of grant with the same vesting schedule and other terms andconditions as the surrendered premium options. This agreement was approved by amajority of the Board of Directors.

 

We refer you to footnotes 4 and 5 to the Executive Compensation Tablefor information on the vesting of the Drexler Restricted Shares.

 

 *JeffreyPfeifle.*  Mr. Pfeifle hasan employment agreement with the Company pursuant to which he will serve asPresident for five years beginning on February 1, 2003, subject toautomatic one-year renewals. The agreement provides for a minimum annual basesalary of $760,000; one-time bonuses in the total amount of $2,000,000 payableafter his commencement date; an annual bonus based on the achievement ofearnings objectives to be determined each year provided that the minimum bonuspayable for fiscal year 2003 would be $400,000; a long-term cash incentivepayment between $800,000 and $1,200,000 based on the achievement of performanceobjectives to be determined each year payable in installments at the end offiscal years 2003 and 2004; and reimbursement of business expenses. Theagreement also provides for (i) the grant of options to purchase 167,378shares of Group common stock at an exercise price equal to $6.82 per share,which we refer to as initial options, and (ii) the grant of premiumoptions to purchase an additional 111,585 shares at an exercise price equal to$25.00 per share and 111,585 shares at an exercise price equal to $35.00 pershare, which we refer to as premium options. The initial options and thepremium options vest in equal annual installments over four years commencing onthe second anniversary of the grant date. The agreement also provides for thegrant of 111,585 shares of Group common stock, which we refer to as the“Pfeifle Restricted Shares.”

 

Pursuant to the agreement, if Mr. Pfeifle’s employment isterminated without “cause” or for “good reason” (each as defined in theemployment agreement), Mr. Pfeifle will be entitled to receive his basesalary for two years, a pro-rated amount of any bonus that he would haveotherwise received for the fiscal year ending before the termination date, andthe immediate vesting of that portion of the initial options, premium optionsand Pfeifle Restricted Shares that would have become vested and exercisable onthe anniversary of the grant date immediately following the termination date.If such termination occurs after a “change in control” (as defined in theservices agreement) or within six months before a “change in control” if incontemplation thereof, all of the unvested initial options, premium options andPfeifle Restricted Shares will immediately vest and become exercisable. If suchtermination occurs before February 1, 2006, Mr. Pfeifle is entitledto receive a minimum of $2,000,000 in the form of cash severance compensation.

 

In September 2003, Mr. Pfeifle received an additional grantof 50,213 Pfeifle Restricted Shares to vest over time. He also surrendered allof his premium options to Group in September 2003. In consideration of thesurrender, we agreed to grant to Mr. Pfeifle replacement premium optionsfollowing a six month period at exercise prices not less than fair market valueon the date of grant with the same vesting schedule and other terms and

 

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conditions as the surrendered premium options. This agreement wasapproved by a majority of the Board of Directors.

 

We refer you to footnote 7 to the Executive Compensation Table forinformation on the vesting of the Pfeifle Restricted Shares.

 

**Separation Agreements**

 

* KathyBoyer.* Ms. Boyer’s employment terminated effective January 5, 2004.Pursuant to her separation agreement, she received a lump sum amount of$103,750 and the continuation of her base salary and medical benefits for threemonths after her termination date.

 

* ScottGilbertson.* Mr. Gilbertson had an employment agreement with the Companypursuant to which he would serve as Chief Operating Officer for five yearscommencing January 27, 2003, subject to automatic one-year renewals. Theagreement provided for a minimum annual base salary of $450,000 and an annualbonus based on achievement of earnings objectives to be determined each yearprovided that the minimum bonus payable for fiscal year 2003 would be $250,000.The agreement also provided for (i) the grant of options to purchase111,585 shares of Group common stock at an exercise price equal to $6.82 pershare, which we refer to as initial options, and (ii) the grant of premiumoptions to purchase an additional 66,951 shares at an exercise price equal to$25.00 per share and 66,951 shares at an exercise price equal to $35.00 pershare, which we refer to as premium options. The initial options and thepremium options were to vest over a four year period in equal annualinstallments commencing on the second anniversary of the grant date. Theagreement also provided for the grant of 111,585 shares of Group common stock,which we refer to as the “Gilbertson Restricted Shares.” We refer you tofootnote 10 to the Executive Compensation Table for information on the scheduledvesting of the Gilbertson Restricted Shares.

 

Pursuant to the agreement, if Mr. Gilbertson’s employment wasterminated without “cause” or for “good reason” (each as defined in theemployment agreement), Mr. Gilbertson would be entitled to receive hisbase salary for eighteen months, a pro-rated amount of any bonus that he wouldhave otherwise received for the fiscal year ending before the termination date,and the immediate vesting of that portion of the initial options, premiumoptions and restricted stock that would have become vested and exercisable onthe anniversary of the grant date immediately following the termination date.If such termination occurs after a “change in control” (as defined inemployment agreement), all of the unvested initial options, premium options andrestricted stock would immediately vest and become exercisable.

 

Mr. Gilberton’s employment terminated in January 2004.Pursuant to his separation agreement, he is entitled to the continuation of hisbase salary for eighteen months and he received the payment of his guaranteedminimum bonus payable for fiscal year 2003. In addition, an initial option topurchase 27,896 shares, premium options to purchase 33,476 shares and 27,896Gilbertson Restricted Shares vested upon his termination and the remainder ofhis initial options, premium options and Gilbertson Restricted Shares wereforfeited immediately. These vested options will terminate on January 31,2006. At the time of his termination, Mr. Gilbertson also had vested options topurchase 25,000 shares at an exercise price equal to $6.82 per shareand 28,000 shares at an exercise price equal to $10.00 per share fromprior grants.

 

**Executive Severance Arrangements**

 

Messrs. Fusco and Hyatt each have an agreement with the Companywhich provides that, in the event of a termination without “cause” (as definedin the agreement), he will receive a continuation of his base salary andmedical benefits for a period of one year after the termination date and thepayment of any bonus that he would otherwise have received for the fiscal yearending before the termination date.

 

**Shareholders Agreements**

 

The Drexler Restricted Shares, the Pfeifle Restricted Shares, theGilbertson Restricted Shares and any shares of Group common stock acquired byany of the named executive officers described above pursuant to the exercise ofoptions are subject to a shareholders’ agreement providing for certain transferrestrictions, registration rights and customary tag-along and drag-alongrights.

 

In addition, Mr. Drexler’s shareholders’ agreement provides himwith certain rights to appoint three directors by himself and three additionaldirectors by mutual agreement with Texas Pacific Group, consent to ouroperating/capital budgets, and antidilution and co-investment rights. Pursuantto this right, Mr. Drexler appointed Steven Grand-Jean as a director inMarch 2003 and Stuart Sloan as a director in September 2003. Theagreement also requires Mr. Drexler to pay $1.0 million to us ifJeffrey Pfeifle, current President of the Company is terminated for cause orresigns without good reason, or if Mr. Pfeifle is terminated without causewith Mr. Drexler’s consent or for good reason as a result of actionsapproved by Mr. Drexler before February 1, 2005. Mr. Drexler isalso required to pay the excess of $480,000 over Mr. Pfeifle’s pro-ratabonus if such termination is without cause or for good reason. If suchtermination occurs between February 1, 2004 and February 1, 2005,Mr. Drexler is also required to pay us the amount of any long-termincentive paid to Mr. Pfeifle, not to exceed $400,000.

 

**Compensation Committee Interlocks and InsiderParticipation**

 

In fiscal 2003, the members of our Compensation Committee wereMessrs. Coulter (Chairman) and Sloan and Ms. Woods. Prior to August 2003,Mr. Boyce was Chairman of the Compensation Committee. Ms. Woods is a

 

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former Chairman, former Chief Executive Officer and formerVice-Chairman of the company. Mr. Boyce is also a former Chief ExecutiveOfficer of the company.

 

**ITEM 12.****                      SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The following table sets forth information regarding the beneficialownership of the common stock of Group as of April 1, 2004 for each personwho is known to Group to be the beneficial owner of 5% or more of Group commonstock. The holders listed have sole voting power and investment power over theshares held by them, except as indicated by the notes following the table.

 
| **Title  of Class** | ** ** | **Name and Address  of Beneficial Owner**                                    | ** ** | **Amount and Nature of  Beneficial Ownership** | ** ** | **Percent of  Class** | ** ** |
|---------------------|------------|------------------------------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------|------------|
|                |       |                                                                         |       |                                           |       |                  |       |
| Common stock        |       | TPG Partners II, L.P.  301 Commerce Street,  Suite 3300 Fort Worth, TX 76102 |       | 8,853,386 shares                               | (1)(4)     | 58                    | %          |
| Common stock        |       | Emily Woods  J. Crew Group, Inc.  770 Broadway  New York, NY 10003           |       | 2,429,177 shares                               | (2)        | 16                    | %          |
| Common stock        |       | Millard S. Drexler  J. Crew Group, Inc.  770 Broadway New York, NY 10003     |       | 1,802,112 shares                               | (3)        | 11                    | %          |

 

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(1)                                  These shares ofcommon stock are beneficially owned by Texas Pacific Group and the followingaffiliates of Texas Pacific Group (collectively, “TPG Affiliates”): TPGParallel II L.P., TPG Partners II L.P., TPG Investors II, L.P., and TPG BacchusII, LLC.

 

(2)                                  Includes 164,000shares not currently owned but which are issuable upon the exercise of stockoptions awarded under our stock option plan that are currently exercisable.

 

(3)                                  Includes(i) 206,730 restricted shares owned by Mr. Drexler; (ii) 55,793restricted shares beneficially owned by a company of which Mr. Drexler isa principal and (iii) 1,539,589 shares not currently owned but which areissuable to Mr. Drexler’s company upon his exercise of an exchange right.We refer you to “Certain Relationships and Related Transactions” for moreinformation.

 

(4)                                  Includes 1,539,589shares not currently owned but which are issuable to TPG Bacchus II, LLC uponits exercise of an exchange right. We refer you to “Certain Relationships andRelated Transactions” for more information.

 

The following table sets forth information regarding the beneficialownership of each class of equity securities of Group as of April 1, 2004for (a) each director, (b) each of the named executive officers and(c) all directors and executive officers as a group. The holders listedhave sole voting power and investment power over the shares held by them,except as indicated by the notes following the table.

 
| **Title  of Class**      | ** ** | **Name of Beneficial Owner**                    | ** ** | **Amount and Nature of  Beneficial Ownership** | ** ** | **Percent of  Class** | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|-----------------------|------------|
|                     |       |                                            |       |                                           |       |                  |       |
| Common stock             |       | Richard Boyce                                   |       | 55,200                                         | (1)        |                  | *          |
| Common stock             |       | Jonathan Coslet                                 |       | 8,853,386                                      | (2)        | 58                    | %          |
| Common stock             |       | James Coulter                                   |       | 8,853,386                                      | (2)        | 58                    | %          |
| Common stock             |       | Steven Grand-Jean                               |       | 1,250                                          | (1)        |                  | *          |
| Common stock             |       | Thomas Scott                                    |       | 1,250                                          | (1)        |                  | *          |
| Common stock             |       | Stuart Sloan                                    |       | 1,250                                          | (1)        |                  | *          |
| Common stock             |       | Josh Weston                                     |       | 26,728                                         | (3)        |                  | *          |
| Common stock             |       | Emily Woods                                     |       | 2,429,177                                      | (4)        | 15                    | %          |
| Common stock             |       | Kathy Boyer (5)                                 |       | 0                                              |       |                  | *          |
| Common stock             |       | Michael Dadario                                 |       | 10,000                                         | (1)        |                  | *          |
| Common stock             |       | Millard Drexler                                 |       | 1,802,112                                      | (6)        | 11                    | %          |
| Common stock             |       | Paul Fusco                                      |       | 21,350                                         | (1)        |                  | *          |
| Common stock             |       | Scott Gilbertson (7)                            |       | 108,792                                        |       |                  | *          |
| Common stock             |       | Scott Hyatt                                     |       | 29,000                                         | (1)        |                  | *          |
| Common stock             |       | Jeffrey Pfeifle                                 |       | 40,449                                         |       |                  | *          |
| Common stock             |       | All directors and executive officers as a group |       | 13,379,944                                     |       | 87                    | %          |
| Series A preferred stock |       | Jonathan Coslet                                 |       | 73,475                                         | (2)        | 79                    | %          |
| Series A preferred stock |       | James Coulter                                   |       | 73,475                                         | (2)        | 79                    | %          |
| Series A preferred stock |       | Josh Weston                                     |       | 60                                             |       |                  | *          |

 

26

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| Series A preferred stock |   | Emily Woods                                     |   | 2,979  |   | 3  | % |
|--------------------------|--------|-------------------------------------------------|--------|--------|--------|----|---|
| Series A preferred stock |   | All directors and executive officers as a group |   | 76,514 | (2)    | 83 | % |

 

----

*                                         Representsless than 1% of the class.

 

(1)                                  These are shares notcurrently owned but which are issuable upon the exercise of stock optionsawarded under our stock option plan that are currently exercisable or becomeexercisable within 60 days.

 

(2)                                  Attributes ownershipof the shares beneficially owned by TPG Affiliates to Messrs. Coslet andCoulter, who are partners of Texas Pacific Group. Includes 1,539,589 shares notcurrently owned but which are issuable to TPG Bacchus II, LLC upon the exerciseof an exchange right. We refer you to “Certain Relationships and RelatedTransactions” for more information. Messrs. Coslet and Coulter disclaimbeneficial ownership of the shares owned by TPG Affiliates.

 

(3)                                  Includes 1,250 sharesnot currently owned but which are issuable upon the exercise of stock optionsawarded under our stock option plan that are currently exercisable or becomeexercisable within 60 days.

 

(4)                                  Includes 164,000 sharesnot currently owned but which are issuable upon the exercise of stock optionsawarded under our stock option plan that are currently exercisable or becomeexercisable within 60 days.

 

(5)                                  Ms. Boyer’semployment terminated in January 2004.

 

(6)                                  Attributes ownershipof the shares beneficially owned by Mr. Drexler’s company toMr. Drexler. Includes 1,539,589 shares not currently owned but which areissuable to Mr. Drexler’s company upon the exercise of an exchange right.We refer you to “Certain Relationships and Related Transactions” for moreinformation.

 

(7)                                  Mr. Gilbertson’semployment terminated in January 2004. Includes 80,896 shares notcurrently owned but which are issuable upon the exercise of stock optionsawarded under our stock option plan that are currently exercisable or becomeexercisable within 60 days.

 

27

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We know of no arrangements, including any pledge by any person of oursecurities, the operation of which may at a subsequent date result in a changein control of the company.

 

**ITEM 13.****                      CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

**Tax Sharing Arrangement**

 

Group and its subsidiaries entered into a tax sharing agreementproviding (among other things) that each of the subsidiaries will reimburseGroup for its share of income taxes determined as if such subsidiary had filedits tax returns on a “separate return” basis.

 

**TPG-MD Investment Notes Payable**

 

On February 4, 2003, Operating Corp. entered into a creditagreement with TPG-MD Investment, LLC, an entity controlled by Texas PacificGroup and Millard Drexler, which provides for:

 

•                                          TrancheA loan in an aggregate principal amount of $10.0 million; and

 

•                                          TrancheB loan in an aggregate principal amount of $10.0 million.

 

The loans are due in February 2008 and bear interest at 5.0% perannum payable semi-annually in arrears on January 31 and July 31,commencing on July 31, 2003. Interest will compound and be capitalized andadded to the principal amount on each interest payment date. Payment of theloans is subordinated in right of payment to the prior payment of all seniordebt and on the same terms as Operating Corp.’s senior subordinated notes. Theloans are guaranteed by certain subsidiaries of Operating Corp.

 

The lender has the right, exercisable at anytime prior to the maturitydate, to exchange the principal amount of and accrued and unpaid interest onthe loans into shares of common stock of Group at an exercise price of $6.82per share. The lender also has the right to require Operating Corp. to prepaythe Tranche B loan without premium or penalty under certain circumstances.

 

Under the terms of TPG-MD Investment, LLC’s operating agreement, thedistributions payable to Mr. Drexler under this credit agreement godirectly to MDJC LLC, an entity whose sole members are Mr. Drexler andGrand-Jean Capital Management, which is turn is owned by Steven Grand-Jean, adirector of the company. As payment for certain financial advisory servicesthat Mr. Grand-Jean rendered to Mr. Drexler and pursuant to MDJCLLC’s operating agreement, Mr. Grand-Jean is entitled to distributionsunder certain circumstances from his equity interest in MDJC LLC.

 

**University Village Lease**

 

Stuart Sloan is the President of UV, Inc., which is the generalpartner of University Village Limited Partnership, the owner and operator ofUniversity Village Shopping Center in Seattle, Washington. On October 14,2003, we entered into a lease agreement with University Village LimitedPartnership with respect to the lease of 7,400 square feet at the UniversityVillage Shopping Center for the operation of one of our retail stores. The termof the lease is 10 years. We expect to receive an allowance for tenant’simprovements in the amount of $450,000 from University Village Limited Partnership.Annual rent due under the lease is comprised of (i) base rent payment of$296,000 for years one through five and $320,000 for years six through ten and(ii) contingent rent payment based on the store’s sales in excess of aspecified threshold. The lease also requires us to pay real estate taxes,insurance and certain common area costs. Mr. Sloan’s sons are thebeneficiaries of trusts that are limited partners of University Village LimitedPartnership.

 

**ITEM 14.****                      PRINCIPALACCOUNTING FEES AND SERVICES**

 

 *AuditFees.*  The aggregate feesbilled to us by the independent auditors, KPMG LLP for professional servicesrendered in connection with the audit of our financial statements included inthis Annual Report on Form 10-K for fiscal 2003, and for review of ourstatements included in our Quarterly Reports on Form 10-Q during fiscal2003, totaled approximately $668,350. The aggregate fees billed to us by KPMGfor professional services rendered in connection with the audit of ourfinancial statements included in our Annual Report on Form 10-K for fiscal2002, and for the review of our financial statements included in our QuarterlyReports on Form 10-Q during fiscal 2002, totaled approximately $546,200.

 

 *Audit-RelatedFees.*  The aggregate feesbilled to us by KPMG for assurance and related services that are reasonablyrelated to the performance of the audit and review of our financial statementsthat are not already reported in the paragraph immediately above totaledapproximately $279,300 and $18,000 for fiscal 2003 and 2002, respectively.These costs primarily related to services provided in connection with ourexchange offer of outstanding senior discount debentures of Group for seniordiscount contingent principal notes of Intermediate in 2003 and for review of executivecompensation agreements in 2002.

 

 *Pre-ApprovalPolicy.*  The Audit Committeehas established policies on the pre-approval of audit and other services thatthe independent auditor may perform for the company. The Committee mustpre-approve the annual audit fees payable to the independent auditor on anannual basis. The Committee must also approve on a case-by-case basis

 

28

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their engagement for any other work to be performed for the companythat is not an integral component of the audit services as well as thecompensation payable to the independent auditor therefore.

 

**PART IV**

 

**ITEM 15.****                      EXHIBITS,FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

 

(a)                                  1. FinancialStatements

 

The following financial statements are included in Item 8:

 

(i)                                     Report of KPMGLLP, Independent Auditors

 

J. Crew Group, Inc. and subsidiaries

 

(ii)                                  Consolidated BalanceSheets as of January 31, 2004 and February 1, 2003

 

(iii)                               Consolidated Statementsof Operations—Years ended January 31, 2004, February 1, 2003 andFebruary 2, 2002

 

(iv)                              Consolidated Statementsof Changes in Stockholders’ Deficit—Years ended January 31, 2004,February 1, 2003 and February 2, 2002

 

(v)                                 ConsolidatedStatements of Cash Flows—Years ended January 31, 2004, February 1,2003 and February 2, 2002

 

J. Crew Intermediate, LLC and subsidiaries

 

(vi)                              Consolidated BalanceSheets as of January 31, 2004 and February 1, 2003

 

(vii)                           Consolidated Statements ofOperations—Years ended January 31, 2004, February 1, 2003 andFebruary 2, 2002

 

(viii)                        Consolidated Statements ofChanges in Membership Interests—Year ended January 31, 2004,February 1, 2003 and February 2, 2002

 

(ix)                                Consolidated Statementsof Cash Flows—Years ended January 31, 2004, February 1, 2003 and February 2,2002

 

J. Crew Operating Corp. and subsidiaries

 

(x)                                   Consolidated BalanceSheets as of January 31, 2004 and February 1, 2003

 

(xi)                                Consolidated Statementsof Operations—Years ended January 31, 2004, February 1, 2003 andFebruary 2, 2002

 

(xii)                             Consolidated Statements ofChanges in Stockholder’s Deficit/Equity—Years ended January 31, 2004,February 1, 2003 and February 2, 2002

 

(xiii)                          Consolidated Statements ofCash Flows—Years ended January 31, 2004, February 1, 2003 andFebruary 2, 2002

 

Notes to consolidated financial statements

 

2.                                       FinancialStatement Schedules

 

Schedule II Valuation and Qualifying Accounts.

 

3.                                       Exhibits

 

The exhibits listed on the accompanying Exhibit Index are incorporatedby reference herein and filed as part of this report.

 

(b)                                 Reports onForm 8-K

 

The Company filed the following reports on Form 8-K during thequarter ended January 31, 2004:

 

Current Report on Form 8-K was filed on December 5, 2003relating to the Company’s financial results for the period endedNovember 1, 2003.

 

Current Report on Form 8-K was filed on January 27, 2004relating to the appointment of Tracy Gardner as Executive Vice-President ofMerchandising, Planning and Production and the resignation of Scott

 

29

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Gilbertson as Chief Operating Officer.

 

(c)                                  Exhibit Index

 

30

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**EXHIBIT INDEX**

 

**Articles of Incorporation and By-Laws**

 
| 3.1                                                                            |   | Restated Certificate of Incorporation of J. Crew Group, Inc.  Incorporated by reference to Exhibit 3.1 to the Registration Statement  on Form S-4, File No. 333-42427, filed December 16, 1997 (the  “Group Registration Statement”).                                                                                                                                                                                                                                                           |
|--------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2                                                                            |   | By-laws of J. Crew Group, Inc., as amended. Incorporated by  reference to Exhibit 3.2 to the Form 10-K for the fiscal year ended  February 3, 2001.                                                                                                                                                                                                                                                                                                                                                            |
| 3.3                                                                            |   | Certificate of Incorporation of J.Crew Operating Corp., as amended.  Incorporated by reference to Exhibits 3.1 and 3.2 to the Registration  Statement on Form S-4, File No. 333-4243, filed December 16,  1997 (the “Operating Registration Statement”).                                                                                                                                                                                                                                                  |
| 3.4                                                                            |   | By-laws of J.Crew Operating Corp., as amended. Incorporated by  reference to Exhibit 3 to the Form 10-Q for the period ended  October 31, 1998 and Exhibit 3.14 to the Operating Registration  Statement.                                                                                                                                                                                                                                                                                                      |
| 3.5                                                                            |   | Certificate of Formation of J.Crew Intermediate LLC. Incorporated by  reference to Exhibit 3.1 to the Registration Statement on Form S-4,  File No. 333-107211, filed July 21, 2003 (the “Intermediate  Registration Statement”).                                                                                                                                                                                                                                                                    |
| 3.6                                                                            |   | Limited Liability Company Agreement of J.Crew Intermediate LLC.  Incorporated by reference to Exhibit 3.2 to the Intermediate  Registration Statement.                                                                                                                                                                                                                                                                                                                                                                        |
| **Instruments Defining the Rights of Security  Holders, Including Indentures** |
| 4.1                                                                            |   | Indenture, dated as of October 17, 1997, between J.Crew Group, Inc.  and State Street Bank and Trust Company. Incorporated by reference to  Exhibit 4.3 to the Group Registration Statement.                                                                                                                                                                                                                                                                                                                        |
| 4.2                                                                            |   | Indenture, dated as of October 17, 1997, between J.Crew  Operating Corp. and State Street Bank and Trust Company. Incorporated by  reference to Exhibit 4.1 to the Operating Registration Statement.                                                                                                                                                                                                                                                                                                                     |
| 4.3                                                                            |   | Registration Rights Agreement, dated as of October 17, 1997, by  and among J. Crew Group, Inc., Donaldson, Lufkin & Jenrette  Securities Corporation and Chase Securities Inc. Incorporated by  reference to Exhibit 4.10 to the Group Registration Statement.                                                                                                                                                                                                                                        |
| 4.4                                                                            |   | Stockholders’ Agreement, dated as of October 17, 1997, between  J. Crew Group, Inc. and the Stockholder signatories thereto.  Incorporated by reference to Exhibit 4.1 to the Group Registration  Statement.                                                                                                                                                                                                                                                                                                   |
| 4.5(a)                                                                         |   | Stockholders’ Agreement, dated as of October 17, 1997, among J.  Crew Group, Inc., TPG Partners II, L.P. and Emily Woods. Incorporated by  reference to Exhibit 10.1 to the Group Registration Statement.                                                                                                                                                                                                                                                                                                      |
| 4.5(b)                                                                         |   | Amendment to Stockholders’ Agreement, dated as of February 3,  2003, among J. Crew Group, Inc., TPG Partners II, L.P. and Emily Woods.  Incorporated by reference to Exhibit 4.1 of the Form 8-K filed on  February 7, 2003.                                                                                                                                                                                                                                                                         |
| 4.6                                                                            |   | Stockholders’ Agreement, dated as of September 9, 2002, between  J. Crew Group, Inc., TPG Partners II, L.P. and Kenneth Pilot.  Incorporated by reference to Exhibit 4.6 to the Form 10-K for  fiscal year ended February 1, 2003.                                                                                                                                                                                                                                                                   |
| 4.7                                                                            |   | Stockholders’ Agreement, dated as of January 24, 2003, among J.  Crew Group, Inc., TPG Partners II, L.P. and Millard Drexler.  Incorporated by reference to Exhibit 4.1 of the Form 8-K filed on  February 3, 2003.                                                                                                                                                                                                                                                                                  |
| 4.8                                                                            |   | Stockholders’ Agreement, dated as of February 20, 2003, among J.  Crew Group, Inc., TPG Partners II, L.P. and Jeffrey Pfeifle.  Incorporated by reference to Exhibit 4.1 of the Form 8-K filed on  February 26, 2003.                                                                                                                                                                                                                                                                                |
| 4.9                                                                            |   | Stockholders’ Agreement, dated as of February 12, 2003, among J.  Crew Group, Inc., TPG Partners II, L.P. and Scott Gilbertson.  Incorporated by reference to Exhibit 4.1 of the Form 8-K filed on  February 14, 2003.                                                                                                                                                                                                                                                                               |
| 4.10                                                                           |   | Credit Agreement, dated as of February 4, 2003, among J. Crew  Group, Inc., J. Crew Operating Corp. and certain subsidiaries thereof,  and TPG-MD Investment LLC. Incorporated by reference to Exhibit 10.1 to  Form 8-K filed on February 7, 2003.                                                                                                                                                                                                                                                       |
| 4.11                                                                           |   | Indenture, dated as of May 6, 2003, between J. Crew Intermediate  LLC and U.S. Bank National Association. Incorporated by reference to  Exhibit 4.1 to the Form 8-K filed on May 6, 2003.                                                                                                                                                                                                                                                                                                                      |
| 4.12                                                                           |   | Registration Rights Agreement, dated as of May 6, 2003, between  J. Crew Intermediate LLC and U.S. Bank National Association. Incorporated by  reference to Exhibit 4.2 to the Form 8-K filed on May 6, 2003.                                                                                                                                                                                                                                                                                                  |
| 4.13                                                                           |   | First Supplemental Indenture, dated as of May 6, 2003, between  J. Crew Intermediate LLC and U.S. Bank National Association, as successor  trustee to State Street Bank and Trust Company. Incorporated by reference as  Exhibit 4.3 to the Form 8-K filed on May 6, 2003.                                                                                                                                                                                                                                     |
| **Material Contracts**                                                         |
| 10.1(a)                                                                        |   | Loan and Security Agreement, dated as of December 23, 2002, by  and among J. Crew Operating Corp., J. Crew Inc., Grace Holmes, Inc.  and H.F.D. No. 55, Inc. as Borrowers, J. Crew Group, Inc. and  J. Crew International, Inc. as Guarantors, Wachovia Bank, National  Association as Arranger, Congress Financial Corporation as Administrative and  Collateral Agent, and the Lenders. Incorporated by reference to  Exhibit 10.1 of the Form 8-K filed on December 27, 2002. |
| 10.1(b)                                                                        |   | Amendment No. 1, dated as of February 7, 2003, to the Loan  and Security Agreement. Incorporated by reference to Exhibit 10.1 of the  Form 8-K filed on February 14, 2003.                                                                                                                                                                                                                                                                                                                                |
| 10.1(c)                                                                        |   | Amendment No. 2, dated as of April 4, 2003, to the Loan and  Security Agreement. Incorporated by reference to Exhibit 10.1 of the Form 8-K  filed on April 8, 2003.                                                                                                                                                                                                                                                                                                                                       |
| 10.2                                                                           |   | Credit Agreement, dated as of February 4, 2003, by and between  J. Crew Group, Inc., J. Crew Operating Corp., and certain subsidiaries  thereof, and TPG-MD Investment, LLC. Incorporated by reference to  Exhibit 10.1 of the Form 8-K filed on February 7, 2003.                                                                                                                                                                                                                                        |

 

31

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| **Management Contracts and Compensatory Plans  and Arrangements** |
|-------------------------------------------------------------------|
| 10.3                                                              |   | Amended and Restated J. Crew Group, Inc. 1997 Stock Option Plan.  Incorporated by reference to Exhibit 10.1 to the Form 10-Q for the  period ended August 3, 2002. |
| 10.4(a)                                                           |   | J. Crew Group, Inc. 2003 Equity Incentive Plan (the “2003  Plan”). Incorporated by reference to Exhibit 10.4 to the Form 10-K  for the fiscal year ended February 1, 2003. |
| 10.4(b)**                                                         |   | Amendment No. 1 to the 2003 Plan. |
| 10.5                                                              |   | Separation Agreement, dated April 29, 2002, between the Company  and Mark Sarvary. Incorporated by reference to Exhibit 10.5(d) to the  Form 10-K for the fiscal year ended February 1, 2003. |
| 10.6                                                              |   | Separation Agreement, dated October 17, 2002, between the  Company and Michael Scandiffio. Incorporated by reference to  Exhibit 10.12 to the Form 10-K for the fiscal year ended  February 1, 2003. |
| 10.7                                                              |   | Separation Agreement, dated January 30, 2003, between the  Company and Blair Gordon. Incorporated by reference to Exhibit 10.7(b)  to the Form 10-K for the fiscal year ended February 1, 2003. |
| 10.8(a)                                                           |   | Employment Agreement, dated August 26, 2002, between the Company  and Kenneth Pilot. Incorporated by reference to Exhibit 10.2 to the  Form 10-Q for the period ended August 3, 2002. |
| 10.8(b)                                                           |   | Separation Agreement, dated January 29, 2003, between the  Company and Kenneth Pilot. Incorporated by reference to Exhibit 10.8(b)  to the Form 10-K for the fiscal year ended February 1, 2003. |
| 10.9(a)                                                           |   | Services Agreement, dated January 24, 2003, between the Company,  Millard S. Drexler, Inc. and Millard Drexler. Incorporated by reference  to Exhibit 10.9 to the Form 10-K for the fiscal year ended  February 1, 2003. |
| 10.9(b)**                                                         |   | Option Surrender Agreement, dated September 25, 2003, between  the Company and Millard Drexler. |
| 10.10(a)                                                          |   | Employment Agreement, dated January 24, 2003, between the  Company and Jeffrey Pfeifle. Incorporated by reference to Exhibit 10.10  to the Form 10-K for the fiscal year ended February 1, 2003. |
| 10.10(b)**                                                        |   | Option Surrender Agreement, dated September 25, 2003, between  the Company and Jeffrey Pfeifle. |
| 10.11(a)                                                          |   | Employment Agreement, dated January 27, 2003, between the  Company and Scott Gilbertson. Incorporated by reference to Exhibit 10.11  to the Form 10-K for the fiscal year ended February 1, 2003. |
| 10.11(b)**                                                        |   | Separation Agreement, dated January 20, 2004, between the  Company and Scott Gilbertson. |
| 10.12                                                             |   | Separation Agreement, dated March 7, 2003, between the Company  and Walter Killough. Incorporated by reference to Exhibit 10.12 to the  Form 10-K for the fiscal year ended February 1, 2003. |
| 10.13                                                             |   | Form of Executive Severance Agreement between the Company and certain  executives thereof. Incorporated by reference to Exhibit 10.14 to Form 10-K  for the fiscal year ended February 2, 2002. |
| 10.14**                                                           |   | Employment Agreement, dated January 23, 2004, between the  Company and Tracy Gardner. |
| 10.15**                                                           |   | Separation Agreement, dated December 23, 2003, and letter  agreement dated, January 26, 2004, between the Company and Kathy Boyer. |
| 10.16**                                                           |   | Employment Agreement, dated April 10, 2004, between the Company  and Amanda Bokman. |
| **Other Exhibits**                                                |
| 14**                                                              |   | Code of Ethics and Business Practices of the Company. |
| 21.1**                                                            |   | Subsidiaries of J. Crew Group, Inc. |
| 23.1*                                                             |   | Consent of KPMG LLP, Independent Auditors. |
| 31.1*                                                             |   | Certification of Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002. |
| 31.2*                                                             |   | Certification of Acting Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
| 32.1*                                                             |   | Certification of Chief Executive Officer and Acting Chief Financial  Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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*                                         Filed herewith

**           Incorporatedby reference to the corresponding Exhibit to the Form 10-K for the fiscal yearended January 31, 2004 as originally filed.

 

32

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, each registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
| Date: October 22, 2004 | J. CREW GROUP, INC.  J. CREW OPERATING CORP.  J. CREW INTERMEDIATE LLC |
|------------------------|------------------------------------------------------------------------|
|                   | By:                                                                    | /s/ Millard S. Drexler |   |
|                   |                                                                   | Millard S. Drexler  Chief Executive Officer |   |

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of eachregistrant and in the capacities indicated, on October22, 2004.

 
| **Signature**         | ** ** | **Title**                                                                             |
|-----------------------|------------|---------------------------------------------------------------------------------------|
|                  |       |                                                                                  |
| /s/ Millard Drexler   |       | Chairman of the Board, Chief Executive Officer and a                                  |
|                  |       | Director (Principal Executive Officer)                                                |
| /s/ Amanda J. Bokman  |       | Executive Vice President & Chief Financial Officer (Principal  Financial Officer) |
|                  |       |                                                                                  |
| /s/ Nicholas Lamberti |       | Vice President, Corporate Controller (Principal Accounting Officer)                   |
|                  |       |                                                                                  |
| /s/ Richard Boyce     |       | Director                                                                              |
|                  |       |                                                                                  |
| /s/ Jonathan Coslet   |       | Director                                                                              |
|                  |       |                                                                                  |
| /s/ James Coulter     |       | Director                                                                              |
|                  |       |                                                                                  |
| /s/ Steven Grand-Jean |       | Director                                                                              |
|                  |       |                                                                                  |
| /s/ Thomas Scott      |       | Director                                                                              |
|                  |       |                                                                                  |
| /s/ Stuart Sloan      |       | Director                                                                              |
|                  |       |                                                                                  |
| /s/ Josh Weston       |       | Director                                                                              |
|                  |       |                                                                                  |
| /s/ Emily Woods       |       | Director                                                                              |

 

 

33

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**INDEX TO FINANCIAL STATEMENTS**

 
| Report of KPMG LLP, Independent Auditors                                                                                                                            |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| J. Crew Group, Inc. and subsidiaries:                                                                                                                               |   |
| Consolidated Balance Sheets as of  January 31, 2004 and February 1, 2003                                                                                  |   |
| Consolidated Statements of Operations-Years  Ended January 31, 2004, February 1, 2003 and February 2, 2002                                           |   |
| Consolidated Statements of Changes in  Stockholders’ Deficit— Years Ended January 31, 2004, February 1,  2003 and February 2, 2002         |   |
| Consolidated Statements of Cash Flows-Years  Ended January 31, 2004, February 1, 2003 and February 2, 2002                                           |   |
| J. Crew Intermediate, LLC and subsidiaries:                                                                                                                         |   |
| Consolidated Balance Sheets as of  January 31, 2004 and February 1, 2003                                                                                  |   |
| Consolidated Statements of Operations-Years  Ended January 31, 2004, February 1, 2003 and February 2, 2002                                           |   |
| Consolidated Statements of Changes in  Membership Interests— Years Ended January 31, 2004, February 1,  2003 and February 2, 2002               |   |
| Consolidated Statements of Cash Flows-Years  Ended January 31, 2004, February 1, 2003 and February 2, 2002                                           |   |
| J. Crew Operating Corp. and subsidiaries:                                                                                                                           |   |
| Consolidated Balance Sheets as of  January 31, 2004 and February 1, 2003                                                                                  |   |
| Consolidated Statements of Operations-Years  Ended January 31, 2004, February 1, 2003 and February 2, 2002                                           |   |
| Consolidated Statements of Changes in  Stockholders’ Equity (Deficit)—Years Ended January 31, 2004,  February 1, 2003 and February 2, 2002 |   |
| Consolidated Statements of Cash Flows-Years  Ended January 31, 2004, February 1, 2003 and February 2, 2002                                           |   |
| Notes to Consolidated Financial Statements                                                                                                                          |   |
| Financial Statement Schedules:                                                                                                                                      |   |
| Schedule II-Valuation and Qualifying  Accounts-Years Ended January 31, 2004, February 1, 2003 and  February 2, 2002                             |   |

 

F-1

----

 

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

**The Board of Directors and Shareholders**

**J. Crew Group, Inc., J. Crew Intermediate LLC, and J. CrewOperating Corp.**

 

We have audited theconsolidated financial statements of J. Crew Group, Inc. (‘‘Group’’), J. CrewIntermediate LLC, a wholly-owned subsidiary of Group (‘‘Intermediate’’), and J.Crew Operating Corp., a wholly-owned subsidiary of Intermediate (‘‘OperatingCorp.’’) (together referred to as the “Companies”) as listed in theaccompanying index. In connection with our audits of the consolidated financialstatements, we also have audited the financial statement schedule listed in theaccompanying index. These consolidated financial statements and financialstatement schedule are the responsibility of the Companies’ management. Ourresponsibility is to express an opinion on these consolidated financialstatements and financial statement schedule based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the consolidated financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallconsolidated financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Group,Intermediate, and Operating Corp. as of January 31, 2004 and February 1, 2003and the results of their operations and their cash flows for each of the yearsin the three-year period ended January 31, 2004, in conformity with accountingprinciples generally accepted in the United States of America. Also, in ouropinion, the related financial statement schedule, when considered in relationto the basic consolidated financial statements taken as a whole, presentsfairly, in all material respects, the information set forth therein.

 

Asdiscussed in Note 6 to the consolidated financial statements, in the thirdquarter of fiscal 2003, Group adopted Statement of Financial AccountingStandards No. 150, ‘‘Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity’’.

 

Asdiscussed in Note 2, the Companies restated the consolidated financialstatements as of and for the period ended January 31, 2004, to reflectthe write-off of certain prepaid sample costs that should have been expensed asincurred.

 

KPMGLLP

NewYork, New York

March25, 2004 (except as to Note 2 which is as of September 9, 2004)

 

 

F-2

----

 

 

**J. CREWGROUP, INC. ANDSUBSIDIARIESConsolidated Balance Sheets(in thousands)**

 
| ** **                                       | ** ** | **January 31,  2004** | ** ** | **February 1,  2003** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
|                                             |       | **(as restated)**          |       |                       |       |
| **Assets**                                       |       |                       |       |                       |       |
| Current assets:                                  |       |                       |       |                       |       |
| Cash and cash equivalents                        |       | $                          | 49,650     |                       | $          | 18,895 |   |
| Merchandise inventories                          |       | 66,028                     |       | 107,318                    |       |
| Prepaid expenses and other current assets        |       | 20,733                     |       | 24,886                     |       |
| Refundable income taxes                          |       | 9,320                      |       | 6,278                      |       |
|                                             |       |                       |       |                       |       |
| Total current assets                             |       | 145,731                    |       | 157,377                    |       |
|                                             |       |                       |       |                       |       |
| Property and equipment — at cost:           |       |                       |       |                       |       |
| Land                                             |       | 1,710                      |       | 1,710                      |       |
| Buildings and improvements                       |       | 11,705                     |       | 11,705                     |       |
| Furniture, fixtures and equipment                |       | 90,898                     |       | 102,108                    |       |
| Leasehold improvements                           |       | 176,740                    |       | 182,226                    |       |
| Construction in progress                         |       | 3,892                      |       | 3,161                      |       |
|                                             |       |                       |       |                       |       |
|                                             |       | 284,945                    |       | 300,910                    |       |
| Less accumulated depreciation and  amortization  |       | 146,565                    |       | 129,363                    |       |
|                                             |       |                       |       |                       |       |
|                                             |       | 138,380                    |       | 171,547                    |       |
|                                             |       |                       |       |                       |       |
| Deferred income tax assets                       |       | —                     |       | 5,000                      |       |
| Other assets                                     |       | 13,500                     |       | 14,954                     |       |
|                                             |       |                       |       |                       |       |
| Total assets                                     |       | $                          | 297,611    |                       | $          | 348,878 |   |
|                                             |       |                       |       |                       |       |
| **Liabilities and Stockholders’ Deficit**   |       |                       |       |                       |       |
| Current liabilities:                             |       |                       |       |                       |       |
| Current portion of long term debt                |       | $                          | 1,164      |                       | $          | — |   |
| Accounts payable                                 |       | 49,386                     |       | 54,921                     |       |
| Other current liabilities                        |       | 47,789                     |       | 61,463                     |       |
| Income taxes payable                             |       | 1,175                      |       | 2,978                      |       |
|                                             |       |                       |       |                       |       |
| Total current liabilities                        |       | 99,514                     |       | 119,362                    |       |
|                                             |       |                       |       |                       |       |
| Deferred credits                                 |       | 56,723                     |       | 65,141                     |       |
|                                             |       |                       |       |                       |       |
| Long-term debt                                   |       | 516,640                    |       | 292,000                    |       |
|                                             |       |                       |       |                       |       |
| Preferred stock                                  |       | 92,800                     |       | 264,038                    |       |
|                                             |       |                       |       |                       |       |
| Stockholders’ deficit                       |       | (468,066                   | )          | (391,663                   | )          |
|                                             |       |                       |       |                       |       |
| Total liabilities and stockholders’ deficit |       | $                          | 297,611    |                       | $          | 348,878 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-3

----

 

**J. CREWGROUP, INC. ANDSUBSIDIARIESConsolidated Statements of Operations(in thousands)**

 
| ** **                                                | ** ** | **Years ended**            | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                | ** ** | **January 31,  2004** | ** ** | **February 1,  2003** | ** ** | **February 2,  2002** | ** ** |
|                                                      |       | **(as restated)**          |       |   |   |   |   |
| Revenues:                                                 |       |                       |       |   |   |   |   |
| Net sales                                                 |       | $                          | 660,628    |   | $ | 732,279 |   | $ | 741,280 |   |
| Other                                                     |       | 27,661                     |       | 34,103 |   | 36,660 |   |
|                                                      |       |                       |       |   |   |   |   |
|                                                      |       | 688,289                    |       | 766,382 |   | 777,940 |   |
| Operating costs and expenses:                             |       |                       |       |   |   |   |   |
| Cost of goods sold, including buying and  occupancy costs |       | 438,600                    |       | 470,300 |   | 454,491 |   |
| Selling, general and administrative expenses              |       | 280,464                    |       | 301,718 |   | 303,448 |   |
|                                                      |       |                       |       |   |   |   |   |
|                                                      |       | 719,064                    |       | 772,018 |   | 757,939 |   |
|                                                      |       |                       |       |   |   |   |   |
| Income/(loss) from operations                             |       | (30,775                    | )          | (5,636 | ) | 20,001 |   |
| Interest expense—net                                 |       | (63,844                    | )          | (40,954 | ) | (36,512 | ) |
| Gain on exchange of debt (net of expenses  of $2,922)     |       | 41,085                     |       | — |   | — |   |
| Insurance proceeds                                        |       | 3,850                      |       | 1,800 |   | — |   |
|                                                      |       |                       |       |   |   |   |   |
| Loss before income taxes                                  |       | (49,684                    | )          | (44,790 | ) | (16,511 | ) |
| Income taxes                                              |       | (500                       | )          | 4,200 |   | 5,500 |   |
|                                                      |       |                       |       |   |   |   |   |
| Net loss                                                  |       | $                          | (50,184    | ) | $ | (40,590 | ) | $ | (11,011 | ) |

 

See accompanying notes to consolidatedfinancial statements.

 

 

F-4

----

 

**J. CREW GROUP, INC. ANDSUBSIDIARIESConsolidated Statements of Changes in Stockholders’ Deficit(in thousands, except shares)**

 
|                                       |       | **Common stock** |       | **Additional   paid-in  capital** |   | **Retained  earnings  (deficit)** |   | **Treasury  stock** |   | **Deferred  compensation** |     | **Stockholders’**

**deficit** |   |
|--------------------------------------------|------------|------------------|------------|-----------------------------------|--------|-----------------------------------|--------|---------------------|--------|----------------------------|----------|-------------------------------------|--------|
|                                       |       |
|                                       | **Shares** |             | **Amount** |                              |
|                                       |       |             |       |                              |   |                              |   |                |   |                       |     |                                |   |   |   |
| Balance at February 3, 2001                |       | 12,232,665       |       | $                                 | 1      |                              | $      | 70,715              |   | $                          | (345,733 | )                                   | $      | (2,351 | ) | $ | (979 | ) | $ | (278,347 | ) |
|                                       |       |             |       |                              |   |                              |   |                |   |                       |     |                                |   |   |   |
| Net loss                                   |       | —           |       | —                            |   | —                            |   | (11,011             | )      | —                     |     | —                              |   | (11,011 | ) |
| Preferred stock dividends                  |       | —           |       | —                            |   | —                            |   | (30,442             | )      | —                     |     | —                              |   | (30,442 | ) |
| Issuance of common stock                   |       | 5,524            |       | —                            |   | 96                                |   | —              |   | —                     |     | —                              |   | 96 |   |
| Amortization of restricted stock           |       | —           |       | —                            |   | —                            |   | —              |   | —                     |     | 661                                 |   | 661 |   |
|                                       |       |             |       |                              |   |                              |   |                |   |                       |     |                                |   |   |   |
| Balance at February 2, 2002                |       | 12,238,189       |       | 1                                 |   | 70,811                            |   | (387,186            | )      | (2,351                     | )        | (318                                | )      | (319,043 | ) |
|                                       |       |             |       |                              |   |                              |   |                |   |                       |     |                                |   |   |   |
| Net loss                                   |       | —           |       | —                            |   | —                            |   | (40,590             | )      | —                     |     | —                              |   | (40,590 | ) |
| Preferred stock dividends                  |       | —           |       | —                            |   | —                            |   | (33,578             | )      | —                     |     | —                              |   | (33,578 | ) |
| Issuance of common stock                   |       | 12,318           |       | —                            |   | 284                               |   | —              |   | —                     |     | —                              |   | 284 |   |
| Issuance of restricted stock               |       | 1,109,266        |       | —                            |   | 1,111                             |   | —              |   | —                     |     | (311                                | )      | 800 |   |
| Amortization of restricted stock           |       | —           |       | —                            |   | —                            |   | —              |   | —                     |     | 464                                 |   | 464 |   |
|                                       |       |             |       |                              |   |                              |   |                |   |                       |     |                                |   |   |   |
| Balance at February 1, 2003                |       | 13,359,773       |       | 1                                 |   | 72,206                            |   | (461,354            | )      | (2,351                     | )        | (165                                | )      | (391,663 | ) |
|                                       |       |             |       |                              |   |                              |   |                |   |                       |     |                                |   |   |   |
| Net loss (as  restated)                    |       | —           |       | —                            |   | —                            |   | (50,184             | )      | —                     |     | —                              |   | (50,184 | ) |
| Preferred stock dividends                  |       | —           |       | —                            |   | —                            |   | (26,260             | )      | —                     |     | —                              |   | (26,260 | ) |
| Issuance of restricted stock               |       | 224,402          |       | —                            |   | 165                               |   | —              |   | —                     |     | (165                                | )      | — |   |
| Amortization of restricted stock           |       | —           |       | —                            |   | —                            |   | —              |   | —                     |     | 41                                  |   | 41 |   |
| Forfeiture of restricted stock             |       | —           |       | —                            |   | —                            |   | —              |   | (62                        | )        | 62                                  |   | — |   |
|                                       |       |             |       |                              |   |                              |   |                |   |                       |     |                                |   |   |   |
| Balance at January 31, 2004  (as restated) |       | 13,584,175       |       | 1                                 |   | 72,371                            |   | (537,798            | )      | (2,413                     | )        | (227                                | )      | (468,066 | ) |
|                                            |            |                  |            |                                   |        |                                   |        |                     |        |                            |          |                                     |        |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidatedfinancial statements.

 

 

F-5

----

 

**J. CREW GROUP, INC.ANDSUBSIDIARIESConsolidated Statements ofCash Flows(in thousands)**

 
| ** **                                                                                                                                                                                                                   | ** ** | **Years ended**            | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                                                                                                   | ** ** | **January 31,  2004** | ** ** | **February 1,  2003** | ** ** | **February 2  2002** | ** ** |
|                                                                                                                                                                                                                         |       | **(as restated)**          |       |   |   |   |   |
| Cash flows from operating activities:                                                                                                                                                                                        |       |                       |       |   |   |   |   |
| Net loss                                                                                                                                                                                                                     |       | $                          | (50,184    | ) | $ | (40,590 | ) | $ | (11,011 | ) |
| Adjustments to reconcile net income/(loss)  to net cash provided by operating activities:                                                                                                                                    |       |                       |       |   |   |   |   |
| Depreciation and amortization                                                                                                                                                                                                |       | 43,075                     |       | 43,197 |   | 39,963 |   |
| Amortization of deferred financing costs                                                                                                                                                                                     |       | 2,179                      |       | 4,435 |   | 1,997 |   |
| Non-cash interest expense                                                                                                                                                                                                    |       | 26,785                     |       | 12,313 |   | 15,395 |   |
| Non-cash preferred stock dividends  (included in interest expense)                                                                                                                                                           |       | 14,206                     |       | — |   | — |   |
| Deferred income taxes                                                                                                                                                                                                        |       | 5,000                      |       | 7,421 |   | (3,460 | ) |
| Non-cash compensation expense                                                                                                                                                                                                |       | 41                         |       | (589 | ) | 1,574 |   |
| Gain on exchange of debt                                                                                                                                                                                                     |       | (41,085                    | )          | — |   | — |   |
| Changes in operating assets and  liabilities:                                                                                                                                                                                |       |                       |       |   |   |   |   |
| Merchandise inventories                                                                                                                                                                                                      |       | 41,290                     |       | 31,600 |   | 1,749 |   |
| Prepaid expenses and other current assets                                                                                                                                                                                    |       | 4,153                      |       | 2,140 |   | (3,286 | ) |
| Other assets                                                                                                                                                                                                                 |       | 832                        |       | (2,470 | ) | (3,416 | ) |
| Accounts payable                                                                                                                                                                                                             |       | (5,535                     | )          | (11,782 | ) | 16,998 |   |
| Other liabilities                                                                                                                                                                                                            |       | (19,698                    | )          | (8,251 | ) | (22,012 | ) |
| Income taxes payable                                                                                                                                                                                                         |       | (4,845                     | )          | (12,140 | ) | (8,741 | ) |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Net cash provided by operating activities                                                                                                                                                                                    |       | 16,214                     |       | 25,284 |   | 25,750 |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Cash flows from investing activities:                                                                                                                                                                                        |       |                       |       |   |   |   |   |
| Capital expenditures                                                                                                                                                                                                         |       | (9,908                     | )          | (26,920 | ) | (61,862 | ) |
| Proceeds from construction allowances                                                                                                                                                                                        |       | 2,022                      |       | 6,502 |   | 19,287 |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Net cash used in investing activities                                                                                                                                                                                        |       | (7,886                     | )          | (20,418 | ) | (42,575 | ) |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Cash flows from financing activities:                                                                                                                                                                                        |       |                       |       |   |   |   |   |
| Proceeds from long term debt                                                                                                                                                                                                 |       | 25,820                     |       | — |   | — |   |
| Costs incurred in refinancing debt                                                                                                                                                                                           |       | (2,617                     | )          | (3,256 | ) | — |   |
| Repayment of long-term debt                                                                                                                                                                                                  |       | (776                       | )          | — |   | — |   |
| Proceeds from the issuance of common stock                                                                                                                                                                                   |       | —                     |       | 1,084 |   | 96 |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Net cash provided by/(used in) financing  activities                                                                                                                                                                         |       | 22,427                     |       | (2,172 | ) | 96 |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Increase (decrease) in cash and cash  equivalents                                                                                                                                                                            |       | 30,755                     |       | 2,694 |   | (16,729 | ) |
| Cash and cash equivalents at beginning of  year                                                                                                                                                                              |       | 18,895                     |       | 16,201 |   | 32,930 |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Cash and cash equivalents at end of year                                                                                                                                                                                     |       | $                          | 49,650     |   | $ | 18,895 |   | $ | 16,201 |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Supplementary cash flow information:                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Income taxes paid                                                                                                                                                                                                            |       | $                          | 345        |   | $ | 453 |   | $ | 6,442 |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Interest paid                                                                                                                                                                                                                |       | $                          | 20,400     |   | $ | 19,380 |   | $ | 19,389 |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Noncash financing activities:                                                                                                                                                                                                |       |                       |       |   |   |   |   |
| Dividends on redeemable preferred stock                                                                                                                                                                                      |       | $                          | 26,260     |   | $ | 33,578 |   | $ | 30,442 |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Interest payable on 13 1¤8%  Senior Discount Debentures at February 1, 2003 capitalized and added to the  principal amount of the debt                                                                                  |       | $                          | 4,416      |   | — |   | — |   |
|                                                                                                                                                                                                                         |       |                       |       |   |   |   |   |
| Exchange of 16% Senior Discount Contingent  Principal Notes of J. Crew Intermediate LLC with a fair value of $87,006,000  for $131,083,000 carrying value of 13 1¤8%  Senior Discount Debentures of J. Crew Group, Inc. |       |                       |       |   |   |   |   |

 

See accompanying notes to consolidatedfinancial statements.

 

 

F-6

----

 

**J. CREW INTERMEDIATE LLCConsolidated Balance Sheets**

**(in thousands)**

 
| ** **                                                                        | ** ** | **January 31,  2004** | ** ** | **February 1,  2003** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
|                                                                              |       | **(as  restated)**         |       |                       |       |
| **Assets**                                                                        |       |                       |       |                       |       |
| Current assets:                                                                   |       |                       |       |                       |       |
| Cash and cash equivalents                                                         |       | $                          | 49,650     |                       | $          | 18,895 |   |
| Merchandise inventories                                                           |       | 66,028                     |       | 107,318                    |       |
| Prepaid expenses and other current assets                                         |       | 20,733                     |       | 24,886                     |       |
| Refundable income taxes                                                           |       | 9,320                      |       | 6,278                      |       |
|                                                                              |       |                       |       |                       |       |
| Total current assets                                                              |       | 145,731                    |       | 157,377                    |       |
|                                                                              |       |                       |       |                       |       |
| Property and equipment—at  cost:                                             |       |                       |       |                       |       |
| Land                                                                              |       | 1,710                      |       | 1,710                      |       |
| Buildings and improvements                                                        |       | 11,705                     |       | 11,705                     |       |
| Furniture, fixtures and equipment                                                 |       | 90,898                     |       | 102,108                    |       |
| Leasehold improvements                                                            |       | 176,740                    |       | 182,226                    |       |
| Construction in progress                                                          |       | 3,892                      |       | 3,161                      |       |
|                                                                              |       |                       |       |                       |       |
|                                                                              |       | 284,945                    |       | 300,910                    |       |
| Less accumulated depreciation and  amortization                                   |       | 146,565                    |       | 129,363                    |       |
|                                                                              |       |                       |       |                       |       |
|                                                                              |       | 138,380                    |       | 171,547                    |       |
|                                                                              |       |                       |       |                       |       |
| Investment in 13 1¤8%  Senior subordinated debentures of J. Crew Group, Inc. |       | 131,083                    |       | —                     |       |
|                                                                              |       |                       |       |                       |       |
| Accrued interest receivable                                                       |       | 12,665                     |       | —                     |       |
|                                                                              |       |                       |       |                       |       |
| Other assets                                                                      |       | 13,333                     |       | 13,646                     |       |
|                                                                              |       |                       |       |                       |       |
| Total assets                                                                      |       | $                          | 441,192    |                       | $          | 342,570 |   |
|                                                                              |       |                       |       |                       |       |
| **Liabilities and Membership Interests**                                          |       |                       |       |                       |       |
| Current liabilities:                                                              |       |                       |       |                       |       |
| Current portion of long term debt                                                 |       | $                          | 1,164      |                       | $          | — |   |
| Accounts payable                                                                  |       | 49,386                     |       | 54,921                     |       |
| Other current liabilities                                                         |       | 46,949                     |       | 56,255                     |       |
| Income taxes payable                                                              |       | 1,175                      |       | 2,978                      |       |
| Deferred income taxes                                                             |       | —                     |       | 910                        |       |
|                                                                              |       |                       |       |                       |       |
| Total current liabilities                                                         |       | 98,674                     |       | 115,064                    |       |
|                                                                              |       |                       |       |                       |       |
| Long-term debt                                                                    |       | 283,269                    |       | 150,000                    |       |
|                                                                              |       |                       |       |                       |       |
| Deferred credits                                                                  |       | 56,723                     |       | 65,141                     |       |
|                                                                              |       |                       |       |                       |       |
| Due to J. Crew Group, Inc.                                                        |       | 8,506                      |       | 2,040                      |       |
|                                                                              |       |                       |       |                       |       |
| Membership interests                                                              |       | (5,980                     | )          | 10,325                     |       |
|                                                                              |       |                       |       |                       |       |
| Total liabilities and membership interests                                        |       | $                          | 441,192    |                       | $          | 342,570 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

 

F-7

----

 

**J. CREW INTERMEDIATE LLCConsolidated Statements of Operations**

**(in thousands)**

 
| ** **                                                | ** ** | **Years Ended**     | ** ** |
|-----------------------------------------------------------|------------|---------------------|------------|
| ** **                                                | ** ** | **January 31 2004** | ** ** | **February 1, 2003** | ** ** | **February 2, 2002** | ** ** |
|                                                      |       | **(as restated)**   |       |   |   |   |   |
| Revenues:                                                 |       |                |       |   |   |   |   |
| Net sales                                                 |       | $                   | 660,628    |   | $ | 732,279 |   | $ | 741,280 |   |
| Other                                                     |       | 27,661              |       | 34,103 |   | 36,660 |   |
|                                                      |       |                |       |   |   |   |   |
|                                                      |       | 688,289             |       | 766,382 |   | 777,940 |   |
| Operating costs and expenses:                             |       |                |       |   |   |   |   |
| Cost of goods sold, including buying and  occupancy costs |       | 438,600             |       | 470,300 |   | 454,491 |   |
| Selling, general and administrative  expenses             |       | 280,423             |       | 301,254 |   | 302,787 |   |
|                                                      |       |                |       |   |   |   |   |
|                                                      |       | 719,023             |       | 771,554 |   | 757,278 |   |
|                                                      |       |                |       |   |   |   |   |
| Income/(loss) from operations                             |       | (30,734             | )          | (5,172 | ) | 20,662 |   |
| Interest expense—net                                 |       | (42,253             | )          | (23,200 | ) | (20,890 | ) |
| Insurance proceeds                                        |       | 3,850               |       | 1,800 |   | — |   |
| Gain on exchange of debt                                  |       | 44,077              |       | — |   | — |   |
| Intercompany interest income                              |       | 12,665              |       | — |   | — |   |
|                                                      |       |                |       |   |   |   |   |
| Loss before income taxes                                  |       | (12,395             | )          | (26,572 | ) | (228 | ) |
| Income taxes                                              |       | 5,410               |       | 17,750 |   | 167 |   |
|                                                      |       |                |       |   |   |   |   |
| Net loss                                                  |       | $                   | (6,985     | ) | $ | (8,822 | ) | $ | (61 | ) |

 

See accompanying notes to consolidated financial statements.

 

F-8

----

 

**J.CREW INTERMEDIATE LLC**

**Consolidated Statement of Changes inMembership Interests**

**(inthousands)**

 
| Balance at February 3, 2001               |   | $      | 19,208 |   |
|------------------------------------------------|--------|--------|--------|--------|
| Net loss                                       |   | (61    | )      |
|                                           |   |   |   |
| Balance at February 2, 2002               |   | 19,147 |   |
| Net loss                                       |   | (8,822 | )      |
|                                           |   |   |   |
| Balance at February 1, 2003               |   | 10,325 |   |
| Net loss (as  restated)                        |   | (6,985 | )      |
| Dividends to affiliates                        |   | (9,320 | )      |
|                                           |   |   |   |
| Balance at January 31, 2004 (as restated) |   | $      | (5,980 | )      |

 

See accompanying notes to consolidated financial statements.

 

F-9

----

 

**J. CREWINTERMEDIATE LLCConsolidated Statements of Cash Flows**

**(in thousands)**

 
| ** **                                                                                                                                                                                                                             | ** ** | **Years ended**       | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                             | ** ** | **January 31,  2004** | ** ** | **February 1,  2003** | ** ** | **February 2,  2002** | ** ** |
|                                                                                                                                                                                                                                   |       | **(as restated)**     |       |   |   |   |   |
| Cash flows from operating activities:                                                                                                                                                                                                  |       |                  |       |   |   |   |   |
| Net income/(loss)                                                                                                                                                                                                                      |       | $                     | (6,985     | ) | $ | (8,822 | ) | $ | (61 | ) |
| Adjustments to reconcile net income/(loss)  to net cash provided by operating activities:                                                                                                                                              |       |                  |       |   |   |   |   |
| Depreciation and amortization                                                                                                                                                                                                          |       | 43,075                |       | 43,197 |   | 39,963 |   |
| Amortization of deferred financing costs                                                                                                                                                                                               |       | 2,099                 |       | 4,202 |   | 1,770 |   |
| Deferred income taxes                                                                                                                                                                                                                  |       | (910                  | )          | (4,694 | ) | 1,873 |   |
| Non-cash interest expense/interest income                                                                                                                                                                                              |       | 9,717                 |       | (1,053 | ) | 913 |   |
| Gain on exchange of debt                                                                                                                                                                                                               |       | (44,077               | )          | — |   | — |   |
| Changes in operating assets and  liabilities:                                                                                                                                                                                          |       |                  |       |   |   |   |   |
| Merchandise inventories                                                                                                                                                                                                                |       | 41,290                |       | 31,600 |   | 1,749 |   |
| Prepaid expenses and other current assets                                                                                                                                                                                              |       | 4,153                 |       | 2,140 |   | (3,286 | ) |
| Other assets                                                                                                                                                                                                                           |       | 832                   |       | (2,470 | ) | (3,416 | ) |
| Accounts payable                                                                                                                                                                                                                       |       | (5,535                | )          | (11,782 | ) | 16,998 |   |
| Other liabilities                                                                                                                                                                                                                      |       | (19,746               | )          | (13,439 | ) | (21,916 | ) |
| Income taxes payable                                                                                                                                                                                                                   |       | (4,845                | )          | (13,409 | ) | (8,741 | ) |
|                                                                                                                                                                                                                                   |       |                  |       |   |   |   |   |
| Net cash provided by operating activities                                                                                                                                                                                              |       | 19,068                |       | 25,470 |   | 25,846 |   |
|                                                                                                                                                                                                                                   |       |                  |       |   |   |   |   |
| Cash flows from investing activities:                                                                                                                                                                                                  |       |                  |       |   |   |   |   |
| Capital expenditures                                                                                                                                                                                                                   |       | (9,908                | )          | (26,920 | ) | (61,862 | ) |
| Proceeds from construction allowances                                                                                                                                                                                                  |       | 2,022                 |       | 6,502 |   | 19,287 |   |
|                                                                                                                                                                                                                                   |       |                  |       |   |   |   |   |
| Net cash used in investing activities                                                                                                                                                                                                  |       | (7,886                | )          | (20,418 | ) | (42,575 | ) |
|                                                                                                                                                                                                                                   |       |                  |       |   |   |   |   |
| Cash flows from financing activities:                                                                                                                                                                                                  |       |                  |       |   |   |   |   |
| Proceeds from long term debt                                                                                                                                                                                                           |       | 25,820                |       | — |   | — |   |
| Transfers to affiliate                                                                                                                                                                                                                 |       | (2,854                | )          | 898 |   | — |   |
| Costs incurred in refinancing debt                                                                                                                                                                                                     |       | (2,617                | )          | (3,256 | ) | — |   |
| Repayment of long-term debt                                                                                                                                                                                                            |       | (776                  | )          | — |   | — |   |
|                                                                                                                                                                                                                                   |       |                  |       |   |   |   |   |
| Net cash provided/(used) in financing  activities                                                                                                                                                                                      |       | 19,573                |       | (2,358 | ) | — |   |
|                                                                                                                                                                                                                                   |       |                  |       |   |   |   |   |
| Increase (decrease) in cash and cash  equivalents                                                                                                                                                                                      |       | 30,755                |       | 2,694 |   | (16,729 | ) |
| Cash and cash equivalents at beginning of  year                                                                                                                                                                                        |       | 18,895                |       | 16,201 |   | 32,930 |   |
|                                                                                                                                                                                                                                   |       |                  |       |   |   |   |   |
| Cash and cash equivalents at end of year                                                                                                                                                                                               |       | $                     | 49,650     |   | $ | 18,895 |   | $ | 16,201 |   |
|                                                                                                                                                                                                                                   |       |                  |       |   |   |   |   |
| Non cash financing activities:                                                                                                                                                                                                         |       |                  |       |   |   |   |   |
| Exchange of 16% Senior Discount Contingent  Principal Notes of J. Crew Intermediate LLC with a face value of  $87,006,000 for $131,083,000 carrying value of 13 1¤8%  Senior Discount Debentures of J. Crew Group, Inc. |       |                  |       |   |   |   |   |

 

See accompanying notes to consolidated financial statements.

 

F-10

----

 

**J. CREW OPERATING CORP. ANDSUBSIDIARIESConsolidated Balance Sheets**

**(in thousands)**

 
| ** **                                              | ** ** | **January 31,  2004** | ** ** | **February 1,  2003** | ** ** |
|---------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
|                                                    |       | **(as restated)**          |       |                       |       |
| **Assets**                                              |       |                       |       |                       |       |
| Current assets:                                         |       |                       |       |                       |       |
| Cash and cash equivalents                               |       | $                          | 49,650     |                       | $          | 18,895 |   |
| Merchandise inventories                                 |       | 66,028                     |       | 107,318                    |       |
| Prepaid expenses and other current assets               |       | 20,733                     |       | 24,886                     |       |
| Refundable income taxes                                 |       | 9,320                      |       | 6,278                      |       |
|                                                    |       |                       |       |                       |       |
| Total current assets                                    |       | 145,731                    |       | 157,377                    |       |
|                                                    |       |                       |       |                       |       |
| Property and equipment—at  cost:                   |       |                       |       |                       |       |
| Land                                                    |       | 1,710                      |       | 1,710                      |       |
| Buildings and improvements                              |       | 11,705                     |       | 11,705                     |       |
| Furniture, fixtures and equipment                       |       | 90,898                     |       | 102,108                    |       |
| Leasehold improvements                                  |       | 176,740                    |       | 182,226                    |       |
| Construction in progress                                |       | 3,892                      |       | 3,161                      |       |
|                                                    |       |                       |       |                       |       |
|                                                    |       | 284,945                    |       | 300,910                    |       |
| Less accumulated depreciation and  amortization         |       | 146,565                    |       | 129,363                    |       |
|                                                    |       |                       |       |                       |       |
|                                                    |       | 138,380                    |       | 171,547                    |       |
|                                                    |       |                       |       |                       |       |
| Other assets                                            |       | 11,091                     |       | 13,646                     |       |
|                                                    |       |                       |       |                       |       |
| Total assets                                            |       | $                          | 295,202    |                       | $          | 342,570 |   |
|                                                    |       |                       |       |                       |       |
| **Liabilities and Stockholder’s Equity (Deficit)** |       |                       |       |                       |       |
| Current liabilities:                                    |       |                       |       |                       |       |
| Current portion of long term debt                       |       | $                          | 1,164      |                       | $          | — |   |
| Accounts payable                                        |       | 49,386                     |       | 54,921                     |       |
| Other current liabilities                               |       | 46,942                     |       | 56,255                     |       |
| Income taxes payable                                    |       | 1,175                      |       | 2,978                      |       |
| Deferred income taxes                                   |       | —                     |       | 910                        |       |
|                                                    |       |                       |       |                       |       |
| Total current liabilities                               |       | 98,667                     |       | 115,064                    |       |
|                                                    |       |                       |       |                       |       |
| Long-term debt                                          |       | 174,880                    |       | 150,000                    |       |
|                                                    |       |                       |       |                       |       |
| Deferred credits                                        |       | 56,723                     |       | 65,141                     |       |
|                                                    |       |                       |       |                       |       |
| Due to J. Crew Group, Inc.                              |       | 5,897                      |       | 2,040                      |       |
|                                                    |       |                       |       |                       |       |
| Stockholder’s equity (deficit)                     |       | (40,965                    | )          | 10,325                     |       |
|                                                    |       |                       |       |                       |       |
| Total liabilities and stockholder’s equity         |       | $                          | 295,202    |                       | $          | 342,570 |   |

 

See accompanying notes to consolidated financial statements.

 

F-11

----

 

**J. CREW OPERATINGCORP. AND****SUBSIDIARIESConsolidated Statements of Operations**

**(in thousands)**

 
| ** **                                                | ** ** | **Years ended**     | ** ** |
|-----------------------------------------------------------|------------|---------------------|------------|
| ** **                                                | ** ** | **January 31 2004** | ** ** | **February 1 2003** | ** ** | **February 2 2002** | ** ** |
|                                                      |       | **(as restated)**   |       |   |   |   |   |
| Revenues:                                                 |       |                |       |   |   |   |   |
| Net sales                                                 |       | $                   | 660,628    |   | $ | 732,279 |   | $ | 741,280 |   |
| Other                                                     |       | 27,661              |       | 34,103 |   | 36,660 |   |
|                                                      |       | 688,289             |            | 766,382 |   | 777,940 |   |
|                                                      |       |                     |       |  |  |  |   |
| Operating costs and expenses:                             |       |                |       |   |   |   |   |
| Cost of goods sold, including buying and  occupancy costs |       | 438,600             |       | 470,300 |   | 454,491 |   |
| Selling, general and administrative  expenses             |       | 280,423             |       | 301,254 |   | 302,787 |   |
|                                                      |       | 719,023             |            | 771,554 |   | 757,278 |   |
|                                                      |       |                     |       |  |  |  |   |
|                                                      |       |                |       |   |   |   |   |
| Income/(loss) from operations                             |       | (30,734             | )          | (5,172 | ) | 20,662 |   |
| Interest expense—net                                 |       | (20,496             | )          | (23,200 | ) | (20,890 | ) |
| Insurance proceeds                                        |       | 3,850               |       | 1,800 |   | — |   |
|                                                      |       |                |       |   |   |   |   |
| Loss before income taxes                                  |       | (47,380             | )          | (26,572 | ) | (228 | ) |
| Income taxes                                              |       | 5,410               |       | 17,750 |   | 167 |   |
|                                                      |       |                |       |   |   |   |   |
| Net loss                                                  |       | $                   | (41,970    | ) | $ | (8,822 | ) | $ | (61 | ) |

 

See accompanying notes to consolidated financial statements.

 

F-12

----

 

**J.CREW OPERATING CORP. AND****SUBSIDIARIESStatement of Changes in Stockholder’s Equity (Deficit)**

**(in thousands)**

 
| Balance, at February 3,  2001              |   | $       | 19,208  |   |
|-------------------------------------------------|--------|---------|---------|--------|
| Net loss                                        |   | (61     | )       |
|                                            |   |    |    |
| Balance, at February 2, 2002               |   | 19,147  |    |
| Net loss                                        |   | (8,822  | )       |
|                                            |   |    |    |
| Balance, at February 1, 2003               |   | 10,325  |    |
| Net loss (as  restated)                         |   | (41,970 | )       |
| Dividends                                       |   | (9,320  | )       |
|                                            |   |    |    |
| Balance, at January 31, 2004 (as restated) |   | $       | (40,965 | )      |

 

Note:  Operating Corp. has authorized 100 shares ofcommon stock, par value $.01 per share, all of which were issued andoutstanding during the three year period ended January 31, 2004.

 

F-13

----

 

**J. CREWOPERATING CORP. ANDSUBSIDIARIESConsolidated Statements of Cash Flows(in thousands)**

 
| ** **                                                                                | ** ** | **Years ended**            | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                | ** ** | **January 31,  2004** | ** ** | **February 1,  2003** | ** ** | **February 2,  2002** | ** ** |
| ** **                                                                                | ** ** | **(as restated)**          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                                     |       |                       |       |   |   |   |   |
| Net income/(loss)                                                                         |       | $                          | (41,970    | ) | $ | (8,822 | ) | $ | (61 | ) |
| Adjustments to reconcile net income/(loss)  to net cash provided by operating activities: |       |                       |       |   |   |   |   |
| Depreciation and amortization                                                             |       | 43,075                     |       | 43,197 |   | 39,963 |   |
| Amortization of deferred financing costs                                                  |       | 1,724                      |       | 4,202 |   | 1,770 |   |
| Deferred income taxes                                                                     |       | (910                       | )          | (4,694 | ) | 1,873 |   |
| Non-cash compensation expense                                                             |       | —                     |       | (1,053 | ) | 913 |   |
| Non-cash interest expense                                                                 |       | 1,000                      |       | — |   | — |   |
| Changes in operating assets and  liabilities:                                             |       |                       |       |   |   |   |   |
| Merchandise inventories                                                                   |       | 41,290                     |       | 31,600 |   | 1,749 |   |
| Prepaid expenses and other current assets                                                 |       | 4,153                      |       | 2,140 |   | (3,286 | ) |
| Other assets                                                                              |       | 832                        |       | (2,470 | ) | (3,416 | ) |
| Accounts payable                                                                          |       | (5,535                     | )          | (11,782 | ) | 16,998 |   |
| Other liabilities                                                                         |       | (19,754                    | )          | (13,439 | ) | (21,916 | ) |
| Income taxes payable                                                                      |       | (4,845                     | )          | (13,409 | ) | (8,741 | ) |
|                                                                                      |       |                       |       |   |   |   |   |
| Net cash provided by operating  activities                                                |       | 19,060                     |       | 25,470 |   | 25,846 |   |
|                                                                                      |       |                       |       |   |   |   |   |
| Cash flows from investing activities:                                                     |       |                       |       |   |   |   |   |
| Capital expenditures                                                                      |       | (9,908                     | )          | (26,920 | ) | (61,862 | ) |
| Proceeds from construction allowances                                                     |       | 2,022                      |       | 6,502 |   | 19,287 |   |
|                                                                                      |       |                       |       |   |   |   |   |
| Net cash used in investing  activities                                                    |       | (7,886                     | )          | (20,418 | ) | (42,575 | ) |
|                                                                                      |       |                       |       |   |   |   |   |
| Cash flows from financing activities:                                                     |       |                       |       |   |   |   |   |
| Proceeds from long term debt                                                              |       | 25,820                     |       | — |   | — |   |
| Transfers to affiliate                                                                    |       | (5,463                     | )          | 898 |   | — |   |
| Costs incurred in refinancing debt                                                        |       | —                     |       | (3,256 | ) | — |   |
| Repayment of long-term debt                                                               |       | (776                       | )          | — |   | — |   |
|                                                                                      |       |                       |       |   |   |   |   |
| Net cash provided/(used) in  financing activities                                         |       | 19,581                     |       | (2,358 | ) | — |   |
|                                                                                      |       |                       |       |   |   |   |   |
| Increase (decrease) in cash and cash  equivalents                                         |       | 30,755                     |       | 2,694 |   | (16,729 | ) |
| Cash and cash equivalents at beginning of  year                                           |       | 18,895                     |       | 16,201 |   | 32,930 |   |
|                                                                                      |       |                       |       |   |   |   |   |
| Cash and cash equivalents at end of year                                                  |       | $                          | 49,774     |   | $ | 18,895 |   | $ | 16,201 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

 

F-14

----

 

**J. CREW GROUP, INC. ANDSUBSIDIARIES**

**Notes to ConsolidatedFinancial StatementsYears ended January 31, 2004, February 1, 2003 and February 2,2002**

 

**(1) Nature Of Business And Summary Of Significant Accounting Policies**

 

*(a) Business*

 

J. Crew Group, Inc. and its wholly ownedsubsidiaries (collectively, the "Company") designs,contracts for the manufacture of, markets and distributes men’s and women’sapparel, shoes and accessories under the J.Crew brand name. The Company’sproducts are marketed, primarily in the United States, through various channelsof distribution, including retail and factory stores, catalogs, and theInternet. The Company is also party to a licensing agreement which grants thelicensee exclusive rights to use the Company’s trademarks in connection withthe manufacture and sale of products in Japan. The license agreement providesfor payments based on a specified percentage of net sales.

 

The Company is subject toseasonal fluctuations in its merchandise sales and results of operations. TheCompany expects its sales and operating results generally to be lower in thefirst and second quarters than in the third and fourth quarters (which includethe back-to-school and holiday seasons) of each fiscal year.

 

A significant amount of the Company’sproducts are produced in the Far East through arrangements with independentcontractors. As a result, the Company’s operations could be adversely affectedby political instability resulting in the disruption of trade from thecountries in which these contractors are located or by the imposition ofadditional duties or regulations relating to imports or by the contractor’sinability to meet the Company’s production requirements.

 

F-15

----

 

(b)            Basis of Presentation

 

The consolidated financialstatements included herein are:

 

a.                                       J. Crew Operating Corp. and its wholly-owned subsidiaries (Operating Corp.)which consist of the accounts of J. Crew Operating Corp and its wholly ownedsubsidiaries.

 

b.                                      J.Crew Intermediate LLC and its wholly-owned subsidiaries (Intermediate) whichconsist of the accounts of J. Crew Intermediate LLC andOperating Corp.

 

c.                                       J.Crew Group, Inc. and its wholly-owned subsidiaries (Group) which consist of theaccounts of J. Crew Group, Inc. and Intermediate.

 

All significant intercompanybalances and transactions are eliminated in consolidation.

 

Intermediate was formed inDelaware as a limited liability company on March 27, 2003. 100% of themembership interests of Intermediate are owned by J. Crew Group, Inc..Effective May 2003, Group transferred its investmentin J. Crew Operating Corp. and subsidiaries to Intermediate. This combinationof entities under common control was accounted for in a manner similar to apooling of interests.

 

On May 6, 2003,Intermediate issued $193,346,138 aggregate principal amount at maturity of 16%Senior Discount Contingent Principal Notes due 2008 in exchange for$131,083,000 in aggregate principal amount (including accrued interest of$10,750,000) of outstanding 13 1¤8%Senior Discount Debentures of J. Crew Group, Inc. The 13 1¤8%Senior Discount Debentures of J. Crew Group, Inc. that were exchanged arebeing held as an asset by Intermediate.

 

The accompanying financialstatements of Intermediate include the balance sheet of Intermediate and itssubsidiaries at January 31, 2004. The statement of operations for the yearended January 31, 2004 includes the operations of J. Crew Operating Corp.and subsidiaries from February 2, 2003 (the predecessor business) and theoperations of Intermediate from date of formation in March 2003 throughJanuary 31, 2004. The financial statements for all years prior toMarch 2003 are the financial statements of J. Crew Operating Corp. andsubsidiaries.

 

*(c) Segment Information*

 

The Company operates in onereportable business segment. All of the Company’s identifiable assets arelocated in the United States. Export sales are not significant.

 

*(d) Fiscal Year*

 

The Company’s fiscal year endson the Saturday closest to January 31. The fiscal years 2003, 2002 and2001 ended on January 31, 2004, February 1, 2003 and February 2,2002 and each fiscal year consisted of 52 weeks.

 

*(e) Cash Equivalents*

 

For purposes of theconsolidated statements of cash flows, the Company considers all highly liquiddebt instruments, with maturities of 90 days or less when purchased, to becash equivalents. Cash equivalents, which were $43,312,000 and $11,224,000 atJanuary 31, 2004 and February 1, 2003, are stated at cost, whichapproximates market value.

 

*(f) Merchandise Inventories*

 

Merchandise inventories arestated at the lower of average cost or market. The Company capitalizes certaindesign, purchasing and warehousing costs in inventory and these costs areincluded in cost of goods sold as the inventories are sold.

 

*(g) Advertising and Catalog Costs*

 

Direct response advertisingwhich consists primarily of catalog production and mailing costs, arecapitalized and amortized over the expected future revenue stream. The Companyaccounts for catalog costs in accordance with the AICPA Statement of Position(“SOP”) 93-7, “Reporting on Advertising Costs.” SOP 93-7 requires that theamortization of capitalized advertising costs be the amount computed using theratio that current period revenues for the catalog cost pool bear to the totalof current and estimated future period revenues for that catalog cost pool. Thecapitalized costs of direct response advertising are amortized, commencing withthe date catalogs are mailed, over the duration of the expected revenue stream,which was four months for the fiscal years 2002, 2003 and 2004. Deferredcatalog costs, included in prepaid expenses and other current assets, as of January 31,2004 and February 1, 2003 were $6,411,000 and $6,197,000. Catalog costs,which are reflected in selling and administrative expenses, for the fiscalyears 2003, 2002 and 2001were $43,978,000, $56,695,000 and $65,477,000.

 

All other advertising costs,which are not significant, are expensed as incurred.

 

F-16

----

 

*(h) Property and Equipment*

 

Property and equipment arestated at cost and are depreciated over the estimated useful lives by thestraight-line method. Buildings and improvements are depreciated over estimateduseful lives of twenty years. Furniture, fixtures and equipment are depreciatedover estimated useful lives, ranging from three to ten years. Leaseholdimprovements are amortized over the shorter of their useful lives or relatedlease terms.

 

Systems development costs arecapitalized and amortized on a straight-line basis over periods ranging fromthree to five years.

 

*(i) Debt Issuance Costs*

 

Debt issuance costs (includedin other assets) are amortized over the term of the related debt agreements.Unamortized debt issuance costs are as follows:

 
| ** **      | ** ** | **January 31, 2004** | ** ** | **February 1, 2003** | ** ** |
|-----------------|------------|----------------------|------------|----------------------|------------|
|            |       |                 |       |                 |       |
| Group           |       | $                    | 167,000    |                 | $          | 1,308,000 |   |
| Intermediate    |       | 2,242,000            |       | —               |       |
| Operating Corp. |       | 3,966,000            |       | 5,435,000            |       |
|            |       |                 |       |                 |       |
|            |       | $                    | 6,375,000  |                 | $          | 6,743,000 |   |

 

*(j) Income Taxes*

 

The Company accounts for incometaxes in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 109, “Accounting for Income Taxes”. This statement requires the use ofthe asset and liability method of accounting for income taxes. Under the assetand liability method, deferred taxes are determined based on the differencebetween the financial reporting and tax bases of assets and liabilities usingenacted tax rates in effect in the years in which the differences are expectedto reverse. The provision for income taxes includes taxes currently payable anddeferred taxes resulting from the tax effects of temporary differences betweenthe financial statement and tax bases of assets and liabilities.

 

*(k) Revenue Recognition*

 

Revenue is recognized forcatalog and internet sales when merchandise is shipped to customers and at thetime of sale for retail sales. Shipping terms for catalog and internet salesare FOB shipping point, and title passes to the customer at the time and placeof shipment. Prices for all merchandise are listed in the Company’s catalogsand website and are confirmed with the customer upon order. The customer has nocancellation privileges other than customary rights of return that areaccounted for in accordance with SFAS No. 48 “*Revenue Recognition When Right of Return Exists*.” TheCompany accrues a sales return allowance for estimated returns of merchandisesubsequent to the balance sheet date that relate to sales prior to the balancesheet date. Amounts billed to customers for shipping and handling fees relatedto catalog and internet sales are included in other revenues at the time ofshipment. Royalty revenue is recognized as it is earned based on contractuallyspecified percentages applied to reported sales. Advance royalty payments aredeferred and recorded as revenue when the related sales occur.

 

*(l) Operating Expenses*

 

Cost of goods sold (includingbuying and occupancy costs) includes the direct cost of purchased merchandise,inbound freight, design, buying and manufacturing costs, occupancy costsrelated to store operations and all shipping and handling and delivery costsassociated with our direct business.

 

Selling, general andadministrative expenses include all operating expenses not included in cost ofgoods sold, primarily catalog production and mailing costs, certain warehousingexpenses, which aggregated $9,860,000, $10,440,000 and $10,725,000 for fiscalyears 2003, 2002 and 2001, respectively, administrative payroll, store expensesother than occupancy costs, depreciation and amortization and credit card fees.

 

*(m) Store Preopening Costs*

 

Costs associated with theopening of new retail and outlet stores are expensed as incurred.

 

*(n) Derivative Financial Instruments*

 

Derivative financialinstruments are used by the Company from time to time to manage its interestrate and foreign currency exposures. For interest rate swap agreements, the netinterest paid is recorded as interest expense on a current basis. Gains orlosses resulting from market fluctuations are not recognized. The Company fromtime to time enters into forward foreign exchange contracts as hedges relatingto identifiable currency positions to reduce the risk from exchange rate fluctuations.

 

F-17

----

 

*(o) Use of Estimates in the Preparation ofFinancial Statements*

 

The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ fromthose estimates.

 

*(p) Impairment of Long-Lived Assets*

 

The Company reviews long-livedassets and certain identifiable intangibles for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. The Company assesses the recoverability of such assets basedupon estimated cash flow forecasts. A charge of $675,000 was incurred in fiscal2003 to writedown the carrying value of certain long-lived assets.

 

*(q) Stock Based Compensation*

 

The Company accounts forstock-based compensation using the intrinsic value method of accounting foremployee stock options as permitted by SFAS No. 123, “Accounting forStock-Based Compensation”. Accordingly, compensation expense is not recordedfor options granted if the option price is equal to or in excess of the fairmarket price at the date of grant. If the Company had adopted the fair valuerecognition provisions of SFAS No. 123, the effect on net income would notbe material.

 

Restricted stock awards resultin the recognition of deferred compensation, which is charged to expense overthe vesting period of the awards. Deferred compensation is presented as areduction of stockholders’ equity. Total compensation expense recorded withrespect to stock-based compensation, all of which related to restricted stockawards, amounted to $41,000, $464,000 and $661,000 in 2003, 2002 and 2001,respectively.

 

*(r) Deferred rent and lease incentives*

 

Rental payments under operatingleases are charged to expense on a straight-line basis after consideration ofstep rent provisions and escalation clauses. Differences between rental expenseand actual rental payments are recorded as deferred rent and included indeferred credits. The Company receives construction allowances upon enteringinto certain store leases. These construction allowances are recorded asdeferred credits and are amortized as a reduction of rent expense over the termof the related lease. Deferred construction allowances were $43,668,000 and$52,061,000 at January 31, 2004 and February 1, 2003, respectively.

 

*(s) Reclassification*

 

Certain prior year amounts havebeen reclassified to conform with current year’s presentation.

 

F-18

----

 

**(2)  Restatement**

 

                In September 2004, the Company concluded that its previously reported financialstatements for the fiscal year ended January 31, 2004 should be restated toreflect the write-off of certain prepaid sample costs whichhad been capitalized as a prepaid asset on the balance sheet and charged toexpense in the period that the inventories associated with the samples weresold. Such costs should have been expensed as incurred. There have been no changes to the totals ofoperating, investing and financing activities included in the statement of cashflows.  There was no change in the income taxprovision, but the components of deferred income tax liabilitiesand the valuation allowance were  adjustedto reflect the taxeffect of the changein prepaid expenses of $1,015,000. Thecorrections which are reflected in the accompanying financial statements as areduction of prepaid expenses and other current assets and an increase in costof goods sold, are as follows:

 
| **Cost of  goods sold:**                       | ** ** | **52  weeks  ended  1/31/04  (in thousands)** | ** **    |
|------------------------------------------------|------------|-----------------------------------------------|---------------|
| as  reported                                   |       | $                                             |  435,700 |   |
| as  restated                                   |       | 438,600                                       |          |
|                                           |       |                                          |          |
| **Net income (loss)**                          |       |                                          |          |
| Group:                                         |       |                                          |          |
| as  reported                                   |       | (47,284                                       | )             |
| as  restated                                   |       | (50,184                                       | )             |
|                                           |       |                                          |          |
| Intermediate:                                  |       |                                          |          |
| as  reported                                   |       | (4,085                                        | )             |
| as  restated                                   |       | (6,985                                        | )             |
|                                           |       |                                          |          |
| Operating  Corp:                               |       |                                          |          |
| as  reported                                   |       | (39,070                                       | )             |
| as  restated                                   |       | (41,970                                       | )             |
|                                           |       |                                          |          |
| **Prepaid  expenses and other current assets** |       |                                          |          |
| as  reported                                   |       | 23,633                                        |          |
| as  restated                                   |       | 20,733                                        |          |
|                                           |       |                                          |          |
| **Stockholders' deficit**                      |       |                                          |          |
| Group:                                         |       |                                          |          |
| as  reported                                   |       | (465,166                                      | )             |
| as restated                                    |       | (468,066                                      | )             |
|                                           |       |                                          |          |
| Intermediate:                                  |       |                                          |          |
| as  reported                                   |       | (3,080                                        | )             |
| as  restated                                   |       | (5,980                                        | )             |
|                                           |       |                                          |          |
| Operating  Corp:                               |       |                                          |          |
| as  reported                              |       | (38,065                                       | )             |
| as  restated                                   |       | (40,965                                       | )             |
|                                                |            |                                               |               |  |

 

F-19

----

 

**(3) Events of September 11, 2001**

 

The terrorist events ofSeptember 11, 2001 resulted in the destruction of the Company’s retailstore located at the World Trade Center in New York City, resulting in the lossof inventories and store fixtures, equipment and leasehold improvements. Theselosses and the resulting business interruption were covered by insurancepolicies maintained by the Company.

 

The statement of operations forthe year ended February 2, 2002 included losses of $1.9 millionrelating to inventories and stores fixtures, equipment and leaseholdimprovements. Insurance recoveries in fiscal 2001 were recorded to the extentof the losses recognized. The statement of operations for the years endedJanuary 31, 2004 and February 1, 2003 include gains of $3,850,000 and$1,800,000 as a result of additional insurance recoveries. No additionalinsurance recoveries are payable to the Company relating to this loss.

 

**(4) Other Current Liabilities**

 

Other current liabilitiesconsist of:

 
| ** **                          | ** ** | **January 31, 2004** | ** ** | **February 1, 2003** | ** ** |
|-------------------------------------|------------|----------------------|------------|----------------------|------------|
|                                |       |                 |       |                 |       |
| Customer liabilities                |       | $                    | 9,089,000  |                 | $          | 9,993,000 |   |
| Accrued catalog and marketing costs |       | 2,505,000            |       | 2,536,000            |       |
| Taxes, other than income taxes      |       | 3,046,000            |       | 2,670,000            |       |
| Accrued interest                    |       | 5,330,000            |       | 9,598,000            |       |
| Accrued occupancy                   |       | 817,000              |       | 1,024,000            |       |
| Reserve for sales returns           |       | 2,988,000            |       | 5,313,000            |       |
| Accrued compensation                |       | 3,535,000            |       | 7,475,000            |       |
| Other                          |       | 20,479,000           |       | 22,854,000           |       |
|                                |       |                 |       |                 |       |
|                                |       | $                    | 47,789,000 |                 | $          | 61,463,000 |   |

 

**(5) Lines of Credit**

 

Operating Corp. entered into aLoan and Security Agreement with Wachovia Bank, N.A., as arranger, CongressFinancial Corporation, as administrative and collateral agent, and a syndicateof lenders which provides 

 

F-20

----

 

for a maximum credit availability of up to$180.0 million (the “Congress Credit Facility”).

 

The Congress Credit Facilityprovides for revolving loans of up to $160.0 million; supplemental loansof up to $20.0 million each year during the period from April 15 toSeptember 15; and letter of credit accommodations. The Congress CreditFacility expires in December 2005. The total amount of availability issubject to limitations based on specified percentages of eligible receivables,inventories and real property. Real property availability is limited to$5.8 million. As of January 31, 2004, there was $18.9 million inavailability under the Congress Credit Facility.

 

Borrowings are secured by aperfected first priority security interest in all the assets of Intermediateand its subsidiaries and bear interest, at the Company’s option, at the primerate plus 0.5% or the Eurodollar rate plus 2.5%. Supplemental loans bearinterest at the prime rate plus 3.0%.

 

The Congress Credit Facilityincludes restrictions, including the incurrence of additional indebtedness, thepayment of dividends and other distributions, the making of investments, thegranting of loans and the making of capital expenditures. The Congress CreditFacility permits restricted payments (by way of dividends or otherdistributions) with respect to, among other things, the Company’s capital stockpayable solely in additional shares of its capital stock, the Company’s taxsharing agreement, the Series A Preferred Stock of Group, the Series B PreferredStock of Group and the 13 1¤8%Senior Discount Debentures due 2008 of Group. The ability of OperatingCorp. to declare dividends on its capital stock is also limited by Delawarelaw, which permits a company to pay dividends on its capital stock only out ofits surplus or, in the event that it has no surplus, out of its net profits forthe year in which a dividend is declared or for the immediately precedingfiscal year. Under the Congress Credit Facility, Operating Corp. is required tomaintain minimum levels of earnings before interest, taxes, depreciation,amortization and certain non-cash items, (“EBITDA”) if excess availability isless than $15.0 million for any 30 consecutive day period. Under theCongress Credit Facility, the assets of Operating Corp. and its subsidiaries arerestricted. Operating Corp. has at all times been in compliance with allfinancial covenants.

 

The Congress Credit Facilitywas amended (a) on February 7, 2003 to provide for an exclusion fromthe definition of consolidated net income for severance and other one-timeemployment-related charges of up to $6.7 million in the last quarter offiscal 2002 and $3.0 million in the first quarter of fiscal 2003 and(b) on April 4, 2003 to (i) consent to the formation of J. CrewIntermediate LLC and the exchange offer; (ii) carve-out from the EBITDAcovenant for fiscal 2002 a $9.0 million one-time charge for non-currentinventory; (iii) modify required EBITDA covenant levels and(iv) eliminate the supplemental loan availability in fiscal 2003. Costs incurredin connection with the February 7, 2003 amendment were insignificant andwere expensed. Costs incurred in connection with the April 4, 2003amendment of $450,000 are being amortized over the remaining term of theagreement.

 

Maximum borrowings underrevolving credit agreements were $10,000,000, $63,000,000 and $95,000,000 andaverage borrowings were $1,020,000, $40,400,000 and $43,100,000 during fiscalyears 2003, 2002 and 2001. There were no borrowings outstanding atJanuary 31, 2004 and February 1, 2003.

 

Outstanding letters of creditestablished primarily to facilitate international merchandise purchases atJanuary 31, 2004 and February 1, 2003 amounted to $39,500,000 and$45,900,000.

 

**(6) Long-Term Debt and Preferred Stock**

 
| ** **                                                                                                    | ** ** | **January 31, 2004** | ** **  | **February 1, 2003** | ** **  |
|---------------------------------------------------------------------------------------------------------------|------------|----------------------|-------------|----------------------|-------------|
|                                                                                                          |       |                 |        |                 |        |
| **OPERATING:**                                                                                                |       |                 |        |                 |        |
| Congress facility(a)                                                                                          |       | $                    | 5,044,000   |                 | $           | — |   |
| 5% notes payable(b)                                                                                           |       | 21,000,000           |        | —               |        |
| 10 3¤8%  senior subordinated notes(c)                                                                    |       | 150,000,000          |        | 150,000,000          |        |
|                                                                                                          |       |                 |        |                 |        |
| Less amount due within one year                                                                               |       | (1,164,000           | )           | —               |        |
|                                                                                                          |       |                 |        |                 |        |
| Total Operating                                                                                               |       | 174,880,000          |        | 150,000,000          |        |
| **INTERMEDIATE:**                                                                                             |       |                 |        |                 |        |
| 16% senior discount contingent principal  notes (net of unamortized debt issuance discount of $38,677,000)(d) |       | 108,389,000          |        | —               |        |
|                                                                                                          |       |                 |        |                 |        |
| Total Intermediate                                                                                            |       | 283,269,000          |        | 150,000,000          |        |
| **GROUP:**                                                                                                    |       |                 |        |                 |        |
| 131¤8%  senior discount debentures(e)                                                                    |       | 21,667,000           |        | $                    | 142,000,000 |   |
| Mandatorily redeemable preferred stock(f)                                                                     |       | 211,704,000          |        | —               |        |
|                                                                                                          |       |                 |        |                 |        |
| Total Group long term debt                                                                                    |       | 516,640,000          |        | 292,000,000          |        |
| Group preferred stock(f)                                                                                      |       | 92,800,000           |        | 264,038,000          |        |
|                                                                                                          |       |                 |        |                 |        |
| Total long term debt and preferred stock                                                                 |       | $                    | 609,440,000 |                 | $           | 556,038,000 |   |

 

F-21

----

 

The scheduled payments of longterm debt are $1.2 million in 2004, $1.2 million in 2005, $1.2 millionin 2006, $151.2 million in 2007 and $190.1 million in 2008 (excludingthe debt issuance discount).

 

*(a)*                               On April 8, 2003,Operating Corp. borrowed the real estate availability of $5.8 millionunder the Congress Credit Facility. This borrowing is repayable at $97,000 permonth commencing June 1, 2003.

 

*(b)*                               On February 4,2003, Group and Operating Corp. enteredinto a credit agreement with TPG-MD Investment, LLC, a related party, whichprovides for a Tranche A loan to Operating Corp. in an aggregate principalamount of $10.0 million and a Tranche B loan to Operating Corp. in anaggregate principal amount of $10.0 million. The loans are due inFebruary 2008 and bear interest at 5.0% per annum payable semi-annually inarrears on January 31 and July 31, commencing on July 31, 2003.Interest will compound and be capitalized and added to the principal amount oneach interest payment date, resulting in an effective interest rate of 5.6%.The outstanding amount of these loans is convertible into shares of commonstock of Group at $6.82 per share. Theseloans are subordinated in right of payment to the prior payment of all seniordebt and are on the same terms as the 10 3¤8%Senior Subordinated Notes due 2008 of Operating Corp.

 

*(c)*                                The senior subordinatednotes are unsecured general obligations of Operating Corp. and are subordinatedin right of payment to all senior debt. Interest on the notes accrues at therate of 10 3¤8% perannum and is payable semi-annually in arrears on April 15 and October 15.The notes mature on October 15, 2007 and may be redeemed at the option ofthe issuer subsequent to October 15, 2002 at prices ranging from 105.188%of principal in 2002 to 100% in 2005 and thereafter. The indenture to thesenior subordinated notes restrict, among other things, the incurrence ofadditional indebtedness, the payments of dividends and other distributions, themaking of investments, the granting of loans and the making of capitalexpenditures. Under the indenture to the senior subordinated notes, OperatingCorp. may declare cash dividends to Group in an amount sufficient toenable Group to make the regularlyscheduled payment of interest in respect of the senior discount debentures of Group only if (i) such interestpayments are made with the proceeds of such dividends, (ii) no default orevent of default has occurred and is continuing under the indenture to thesenior subordinated notes of Operating Corp. and (iii) immediately beforeand immediately after giving effect to such declaration of dividends, OperatingCorp.’s fixed charge coverage ratio would have been at least 2.0 to 1.0 on apro forma basis for its most recently ended four fiscal quarters immediatelypreceding the date of such declaration, as if such declaration had beenincurred at the beginning of such four-quarter period.

 

The ability ofOperating Corp. to declare dividends on its capital stock is also limited byDelaware law, which permits a company to pay dividends on its capital stockonly out of its surplus or, in the even that it has no surplus, out of its netprofits for the year in which a dividend is declared or for the immediatelypreceding fiscal year. In order to pay dividends in cash, Operating Corp. musthave surplus or net profits equal to the full amount of the cash dividend atthe time such dividend is declared. In determining Operating Corp.’s ability topay dividends, Delaware law permits the board of directors of Operating Corp.to revalue its assets and liabilities from time to time to their fair marketvalues in order to create a surplus. Under the indenture governing the seniorsubordinated notes, the assets of the Operating Corp. and its subsidiaries arerestricted.

 

*(d)*                               On May 6, 2003, Group (through its newly-formed,wholly owned subsidiary, Intermediate) completed an offer to exchange16% Senior Discount Contingent Principal Notes due 2008 of Intermediate (newnotes) for its outstanding 13 1¤8%Senior Discount Debentures due 2008 (existing debentures). Approximately 85% ofthe outstanding debentures were tendered for exchange. The new notes are thedirect, unsecured and unconditional obligations of Intermediate.

 

Intermediateexchanged $87,006,000 fair value of new notes for $131,083,000 face amount(including accrued interest of $10,750,000) of existing debentures. Thedifference between the fair value of the new notes and the carrying value ofthe existing debentures is included as a gain in the statement of operationsfor the year ended January 31, 2004. The new notes were initially recordedat their fair value and the debt issuance discount of $44,077,000 will beaccreted to the principal amount over the life of the new notes as additionalinterest expense.

 

Interest fromOctober 15, 2002 through May 5, 2003 was paid on the existingdebentures not exchanged at 13 1¤8%.Interest from October 15, 2002 through May 5, 2003 on the existingdebentures that were exchanged was added to the principal amount at 16% inaccordance with the terms of the exchange offer. The new notes bear interest at16% payable in arrears on May 15 and November 15. Interest from dateof issuance through November 15, 2005 will be added to the principalamount of the new notes. Effective November 15, 2005, interest will accrueand become payable on each May 15 and November 15 thereafter throughMay 15, 2008.

 

Commencing onMay 15, 2004 and on each May 15 through May 15, 2008, theaccreted value of the new notes will be increased by 10% of earnings beforeinterest, taxes and depreciation and amortization [EBITDA] in excess of$50.0 million for the immediately preceding fiscal year. Interest at 16%will accrue on such increase in principal.

 

*(e)*                                The senior discountdebentures were issued in aggregate principal amount of $142.0 million atmaturity 

 

F-22

----

 

and mature onOctober 15, 2008. These debentures are senior unsecured obligations of Group. Cash interest did notaccrue prior to October 15, 2002. However, Group recorded non-cash interestexpense as an accretion of the principal amount of the debentures at a rate of13 1¤8% perannum. Interest is payable in arrears on April 15 and October 15 ofeach year subsequent to October 15, 2002. The senior discount debenturesmay be redeemed at the option of Group on or after October 15,2002 at prices ranging from 106.563% of principal to 100% in 2005 andthereafter (see note (d) for description of debt exchange).

 

*(f)*                                   The restatedcertificate of incorporation authorizes Group to issue up to:

 

*(a)*          1,000,000shares of Series A cumulative preferred stock; par value $.01 per share;and

 

*(b)*          1,000,000shares of Series B cumulative preferred stock; par value $.01 per share.

 

AtJanuary 31, 2004, 92,800 shares of Series A Preferred Stock and32,500 shares of Series B Preferred Stock were issued and outstanding.

 

The PreferredStock accumulates dividends at the rate of 14.5% per annum (payable quarterly)for periods ending on or prior to October 17, 2009. Dividends compound tothe extent not paid in cash. A default in the payment of the Series Apreferred stock redemption price will trigger dividends accruing andcompounding quarterly at a rate of (i) 16.50% per annum with respect toperiods ending on or before October 17, 2009 and (ii) 18.50% withrespect to periods starting after October 17, 2009. A default in thepayment of the Series B preferred stock redemption price will triggerdividends accruing and compounding quarterly at a rate of 16.50% per annum.

 

On October 17, 2009, Group is required to redeem theSeries B Preferred Stock and to pay all accumulated but unpaid dividendson the Series A Preferred Stock. Thereafter, the Series A PreferredStock will accumulate dividends at the rate of 16.5% per annum. Subject torestrictions imposed by certain indebtedness of the Company, Group may redeem shares of thePreferred Stock at October 17, 2000 and thereafter at a redemption priceequal to 100% of liquidation value plus accumulated and unpaid dividends atOctober 17, 2000 and thereafter.

 

In certain circumstances(including a change of control of Group), subject to restrictionsimposed by certain indebtedness of the Company, Group may be required torepurchase shares of the Preferred Stock at liquidation value plus accumulatedand unpaid dividends. If Group liquidates, dissolves orwinds up, whether voluntary or involuntary, no distribution shall be madeeither (i) to those holders of stock ranking junior to the PreferredStock, unless prior thereto the holders of the Preferred Stock receive thetotal value for each share of Preferred Stock plus an amount equal to allaccrued dividends thereon as of the date of such payment or (ii) to theholders of stock ranking *pari passu*with the Preferred Stock (which we refer to as the “parity stock”), exceptdistributions made ratably on the Preferred Stock and all such parity stock inproportion to the total amounts to which the holders of all such shares areentitled upon liquidation, dissolution or winding up of Group.

 

Effective at the beginning ofthe third quarter of 2003, the Company adopted SFAS No. 150 “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity”. This pronouncement required the reclassification to long term debt ofthe liquidation value of Group’ Series B PreferredStock and the related accumulated and unpaid dividends and the accumulated andunpaid dividends related to the Series A Preferred Stock since theseamounts are required to be redeemed in October 2009. The preferreddividends related to the liquidation value of the Series B Preferred Stockand to the accumulated and unpaid dividends of the Series A andSeries B Preferred stock for the third and fourth quarters of 2003 areincluded in interest expense. The Series A preferred stock is onlyredeemable in certain circumstances (including a change of control at Group) and does not qualify forreclassification under SFAS No. 150. Accordingly, the dividends related tothe Series A Preferred Stock were deducted from stockholders’ deficit.

 

Accumulated but unpaiddividends amounted to $179,204,000 at January 31, 2004.

 

**(7) Common Stock**

 

The restated certificate ofincorporation authorizes Group to issue up to 100,000,000shares of common stock; par value $.01per share. At January 31, 2004,shares issued were 13,584,175 and shares outstanding were 13,011,086. During2001and 2002 directors converted fees into 5,524 and 12,318 shares of Group common stock.

 

**(8) Commitments and Contingencies**

 

*(a) Operating Leases*

 

As of January 31, 2004,Operating Corp. was obligated under various long-term operating leases forretail and outlet stores, warehouses, office space and equipment requiring minimumannual rentals. These operating leases expire on varying dates through 2014. AtJanuary 31, 2004 aggregate minimum rentals in future periods are, asfollows:

 
| **Fiscal  year** | ** ** | **Amount**  | ** ** |
|------------------|------------|-------------|------------|
|             |       |        |       |
| 2004             |       | $           | 52,351,000 |   |
| 2005             |       | 49,607,000  |       |
| 2006             |       | 46,838,000  |       |
| 2007             |       | 44,970,000  |       |
| 2008             |       | 39,377,000  |       |
| Thereafter  |       | 116,189,000 |       |
|                  |            |             |            |  |

 

F-23

----

 

Certain of these leases includerenewal options and escalation clauses and provide for contingent rentals basedupon sales and require the lessee to pay taxes, insurance and other occupancycosts.

 

Rent expense for fiscal 2003,2002 and 2001 was $42,997,000, $41,657,000 and $38,326,000 including contingentrent based on store sales of $814,000, $1,187,000, and $1,023,000.

 

*(b) Employment Agreements*

 

The Company is party toemployment agreements with certain executives which provide for compensationand certain other benefits. The agreements also provide for severance paymentsunder certain circumstances.

 

*(c) Litigation*

 

The Company is subject tovarious legal proceedings and claims that arise in the ordinary conduct of itsbusiness. Although the outcome of these claims cannot be predicted withcertainty, management does not believe that it is reasonably possible thatresolution of these legal proceedings will result in unaccrued losses thatwould be material.

 

**(9) Employee Benefit Plan**

 

The Company has athrift/savings plan pursuant to Section 401 of the Internal Revenue Codewhereby all eligible employees may contribute up to 15% of their annual basesalaries subject to certain limitations. The Company’s contribution is based ona percentage formula set forth in the plan agreement. Company contributions tothe thrift/savings plan were $1,288,000, $1,834,000 and $1,334,000 for fiscal2003, 2002 and 2001.

 

**(10)  License Agreement**

 

Operating Corp. has a licensingagreement through January 2007 with Itochu Corporation, a Japanese tradingcompany. The agreement permits Itochu to distribute J. Crew merchandise inJapan.

 

OperatingCorp. earns royalty payments under the agreement based on the sales of itsmerchandise. Royalty income, which is included in other revenues, for fiscal2003, 2002, and 2001 was $2,456,000, $2,280,000 and $2,560,000, respectively.

 

**(11) Interest Expense—net**

 

Interest expense, net consistsof the following:

 
| ** **                                                   | ** ** | **2003**   | ** **     | **2002**   | ** ** | **2001**       | ** ** |
|--------------------------------------------------------------|------------|------------|----------------|------------|------------|----------------|------------|
|                                                         |       |       |           |       |       |           |       |
| **Group**                                                    |       |       |           |       |       |           |       |
| Interest expense                                             |       | $          | 7,305,000      |       | $          | 17,521,000     |       | $ | 15,395,000 |   |
| Dividends related to mandatorily redeemable  preferred stock |       | 14,206,000 |           | —     |       | —         |       |
| Amortization of deferred financing costs                     |       | 80,000     |           | 233,000    |       | 227,000        |       |
|                                                         |       |       |           |       |       |           |       |
|                                                         |       | 21,591,000 |           | 17,754,000 |       | 15,622,000     |       |
|                                                         |       |       |           |       |       |           |       |
| **Intermediate**                                             |       |       |           |       |       |           |       |
| Interest expense                                             |       | 15,982,000 |           | —     |       | —         |       |
| Amortization of debt issuance discount                       |       | 5,400,000  |           | —     |       | —         |       |
| Amortization of deferred financing costs                     |       | 375,000    |           | —     |       | —         |       |
|                                                         |       |       |           |       |       |           |       |
|                                                         |       | 21,757,000 |           | —     |       | —         |       |
|                                                         |       |       |           |       |       |           |       |
| **Operating Corp.**                                          |       |       |           |       |       |           |       |
| Interest expense                                             |       | 18,946,000 |           | 19,027,000 |       | 19,415,000     |       |
| Amortization                                                 |       | 1,712,000  |           | 4,202,000  |       | 1,770,000      |       |
| Interest income                                         |       | (162,000   | )              | (29,000    | )          | (295,000       | )          |
|                                                         |       |       |           |       |       |           |       |
|                                                         |       | 20,496,000 |           | 23,200,000 |       | 20,890,000     |       |
|                                                         |       |       |           |       |       |           |       |
| **Total**                                                    | ** ** | **$**      | **63,844,000** | ** ** | **$**      | **40,954,000** | ** ** | **$** | **36,512,000** | ** ** |

 

----

(a)                                  Deferredfinancing costs of $1,800,000 were written off in fiscal 2002 in connectionwith the refinancing of our revolving credit facility.

 

F-24

----

 

 

**(12)  Other Revenues**

 

Other revenuesconsist of the following:

 
| ** **                 | ** ** | **2003**  | ** ** | **2002**  | ** ** | **2001**   | ** ** |
|----------------------------|------------|-----------|------------|-----------|------------|------------|------------|
|                       |       |      |       |      |       |       |       |
| Shipping and handling fees |       | $         | 25,205,000 |      | $          | 31,823,000 |       | $ | 34,100,000 |   |
| Royalties             |       | 2,456,000 |       | 2,280,000 |       | 2,560,000  |       |
|                       |       |      |       |      |       |       |       |
|                       |       | $         | 27,661,000 |      | $          | 34,103,000 |       | $ | 36,660,000 |   |

 

**(13)  Financial Instruments**

 

The fair valueof the Company’s long-term debt is estimated to be approximately $293,896,000and $238,692,000 at January 31, 2004 and February 1, 2003 and isbased on dealer quotes or quoted market prices of the same or similarinstruments. The carrying amounts of long-term debt were $306,100,000 and$292,000,000 at January 31, 2004 and February 1, 2003. The carryingamounts reported in the consolidated balance sheets for cash and cashequivalents, accounts payable and other current liabilities approximate fairvalue because of the short-term maturity of those financial instruments. Theestimates presented herein are not necessarily indicative of amounts theCompany could realize in a current market exchange.

 

F-25

----

 

**(14)  Income Taxes**

 

Groupfiles a consolidated federal tax return which includes all its wholly ownedsubsidiaries. Each subsidiary files separate state tax returns in the requiredjurisdictions. Group and its subsidiaries haveentered into a tax sharing agreement providing (among other things) that eachof the subsidiaries will reimburse Group for its share of incometaxes determined as if such subsidiary had filed its tax returns on a separatereturn basis.

 

*Group*

 

The income taxprovision/(benefit) of Group consists of:

 
| ** **      | ** ** | **2003**   | ** ** | **2002**    | ** ** | **2001**   | ** ** |
|-----------------|------------|------------|------------|-------------|------------|------------|------------|
|            |       |       |       |        |       |       |       |
| Current:        |       |       |       |        |       |       |       |
| Foreign         |       | $          | 250,000    |        | $          | 193,000    |       | $ | 260,000 |   |
| Federal         |       | (3,744,000 | )          | (12,014,000 | )          | (2,400,000 | )          |
| State and local |       | (1,006,000 | )          | 200,000     |       | 100,000    |       |
|            |       |       |       |        |       |       |       |
|            |       | (4,500,000 | )          | (11,621,000 | )          | (2,040,000 | )          |
|            |       |       |       |        |       |       |       |
| Deferred        |       | 5,000,000  |       | 7,421,000   |       | (3,460,000 | )          |
|            |       |       |       |        |       |       |       |
| Total      |       | $          | 500,000    |        | $          | (4,200,000 | )          | $ | (5,500,000 | ) |

 

Areconciliation between the provision/(benefit) for income taxes based on theU.S. Federal statutory rate and the Company’s effective rate is as follows.

 
| ** **                                            | ** ** | **2003**          | ** ** | **2002** | ** ** | **2001** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|----------|------------|----------|------------|
|                                                  |       | **(as restated)** |       |     |       |     |       |
| Federal income tax rate                               |       | (35.0             | )%         | (35.0    | )%         | (35.0    | )%         |
| State and local income taxes, net of  federal benefit |       | .8                |       | —   |       | (2.3     | )          |
| Valuation allowance                                   |       | 64.0              |       | 47.0     |       | —   |       |
| Additional NOL carryback                              |       | (7.4              | )          | —   |       | —   |       |
| Reversal of prior tax accruals                        |       | (2.6              | )          | (20.9    | )          | —   |       |
| Nondeductible expenses and other                      |       | 8.4               |       | (0.5     | )          | 4.0      |       |
| Non-recognized gain on exchange of debt               |       | (27.2             | )          | —   |       | —   |       |
|                                                  |       |              |       |     |       |     |       |
| Effective tax rate                               |       | 1.0               | %          | (9.4     | )%         | (33.3    | )%         |

 

The tax effectof temporary differences which give rise to deferred tax assets and liabilitiesare:

 
| ** **                                                   | ** ** | **January 31, 2004** | ** ** | **February 1, 2003** | ** ** |
|--------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
|                                                         |       | **(as restated)**    |       |                 |       |
| Deferred tax assets:                                         |       |                 |       |                 |       |
| Original issue discount                                      |       | $                    | 33,660,000 |                 | $          | 24,896,000 |   |
| Rent                                                         |       | 17,514,000           |       | 20,900,000           |       |
| Federal NOL carryforwards                                    |       | 19,600,000           |       | 7,100,000            |       |
| State and local NOL carryforwards                            |       | 4,485,000            |       | 1,400,000            |       |
| Reserve for sales returns                                    |       | 1,207,000            |       | 2,202,000            |       |
| Other                                                        |       | 5,057,000            |       | 3,873,000            |       |
|                                                         |       |                 |       |                 |       |
|                                                         |       | 81,523,000           |       | 60,371,000           |       |
| Valuation allowance                                          |       | (57,838,000          | )          | (21,046,000          | )          |
|                                                         |       | 23,685,000           |       | 39,325,000           |       |
|                                                         |       |                 |       |                 |       |
| Deferred tax liabilities:                                    |       |                 |       |                 |       |
| Prepaid catalog and other prepaid expenses                   |       | (8,555,000           | )          | (9,872,000           | )          |
| Difference in book and tax basis for  property and equipment |       | (15,130,000          | )          | (24,453,000          | )          |
|                                                         |       | (23,685,000          | )          | (34,325,000          | )          |
|                                                         |       |                 |       |                 |       |
|                                                         |       |                 |       |                 |       |
| Net deferred income tax asset                           |       | $               | —     |                 | $          | 5,000,000 |   |
|                                                              |            |                      |            |                      |            |  |  |  |

 

F-26

----

 

*Operating Corp.*

 

The income taxprovision/(benefit) of Operating Corp. consists of:

 
| ** **      | ** ** | **2003**   | ** ** | **2002**    | ** ** | **2001**    | ** ** |
|-----------------|------------|------------|------------|-------------|------------|-------------|------------|
|            |       |       |       |        |       |        |       |
| Current:        |       |       |       |        |       |        |       |
| Foreign         |       | $          | 250,000    |        | $          | 193,000     |       | $ | 260,000 |   |
| Federal         |       | (3,744,000 | )          | (13,449,000 | )          | (2,400,000  | )          |
| State and local |       | (1,006,000 | )          | 200,000     |       | 100,000     |       |
|            |       |       |       |        |       |        |       |
|            |       | (4,500,000 | )          | (13,056,000 | )          | (2,040,000  | )          |
|            |       |       |       |        |       |        |       |
| Deferred        |       | (910,000   | )          | (4,694,000  | )          | 1,873,000   |       |
|            |       |       |       |        |       |        |       |
| Total           |       | $          | (5,410,000 | )           | $          | (17,750,000 | )          | $ | (167,000 | ) |

 

Areconciliation between the provision/(benefit) for income taxes based on theU.S. Federal statutory rate and the Company’s effective rate as follows:

 
| ** **                                            | ** ** | **2003**          | ** ** | **2002** | ** ** | **2001** | ** ** |
|-------------------------------------------------------|------------|-------------------|------------|----------|------------|----------|------------|
|                                                  |       | **(as restated)** |       |     |       |     |       |
| Federal income tax rate                               |       | (35.0             | )%         | (35.0    | )%         | (35.0    | )%         |
| State and local income taxes, net of  federal benefit |       | .8                |       | —   |       | 134.6    |       |
| Valuation allowance                                   |       | 36.9              |       | —   |       |     |       |
| Additional NOL carryback                              |       | (7.8              | )          | —   |       | —   |       |
| Reversal of prior tax accruals                        |       | (2.7              | )          | (38.6    | )          | —   |       |
| Nondeductible expenses and other                      |       | (3.6              | )          | 6.8      |       | (172.8   | )          |
|                                                  |       |              |       |     |       |     |       |
| Effective tax rate                                    |       | (11.4             | )%         | (66.8    | )%         | (73.2    | )%         |

 

The tax effectof temporary differences which give rise to deferred tax assets and liabilitiesare:

 
| ** **                                                   | ** ** | **January 31,  2004** | ** ** | **February 1,  2003** | ** ** |
|--------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
|                                                         |       | **(as  restated)**         |            |                       |       |
| Deferred tax assets:                                         |       |                       |       |                       |       |
| Federal NOL carryforwards                                    |       | $                          | 17,540,000 |                       | $          | 5,040,000 |   |
| State and local NOL carryforwards                            |       | 4,485,000                  |       | 1,400,000                  |       |
| Reserve for sales returns                                    |       | 1,207,000                  |       | 2,202,000                  |       |
| Rent                                                         |       | 17,514,000                 |       | 20,995,000                 |       |
| Other                                                        |       | 5,459,000                  |       | 3,873,000                  |       |
|                                                         |       |                       |       |                       |       |
|                                                         |       | 46,205,000                 |       | 33,510,000                 |       |
| Valuation allowance                                          |       | (22,520,000                | )          | —                     |       |
|                                                         |       | 23,685,000                 |       | 33,510,000                 |       |
|                                                         |       |                       |       |                       |       |
| Deferred tax liabilities:                                    |       |                       |       |                       |       |
| Prepaid catalog and other prepaid expenses                   |       | (8,555,000                 | )          | (9,872,000                 | )          |
| Difference in book and tax basis for  property and equipment |       | (15,130,000                | )          | (24,548,000                | )          |
|                                                         |       | (23,685,000                | )          | (34,420,000                | )          |
|                                                         |       |                       |       |                       |       |
|                                                         |       |                       |       |                       |       |
| Net deferred income tax liability                            |       | $                          | —     |                       | $          | (910,000 | ) |

 

The Companyhas significant deferred tax assets resulting from net operating losscarryforwards and deductible temporary differences, which will reduce taxableincome in future periods. SFAS No. 109 “Accounting for Income Taxes”states that a valuation allowance is required when it is more likely than notthat all or a portion of a deferred tax asset will not be realized. A review ofall available positive and negative evidence needs to be

 

F-27

----

 

considered, including acompany’s current and past performance, the market environment in which acompany operates, length of carryback and carryforward periods, existingcontracts or sales backlog that will result in future profits, etc. Forming aconclusion that a valuation allowance is not needed is difficult when there isnegative evidence such as cumulative losses in recent years. Cumulative lossesweigh heavily in the overall assessment. As a result of our assessment, weestablished a valuation allowance for the net deferred tax assets atFebruary 1, 2003. The valuation allowance was increased atJanuary 31, 2004 to fully reserve net deferred tax assets at that date.The Company does not expect to recognize any tax benefits in future results ofoperations until an appropriate level of profitability is sustained.

 

The Companyhas state and local income tax net operating loss carryforwards of varyingamounts.

 

**(15)Stock Compensation Plans**

 

*1997 Stock Option Plan*

 

Under theterms of the 1997 Stock Option Plan, an aggregate of 1,910,000 shares areavailable for grant to certain key employees or consultants. The options haveterms of seven to ten years and become exercisable over a period of four tofive years. Options granted under the Option Plan are subject to variousconditions, including under some circumstances, the achievement of certainperformance objectives.

 

*2003 Equity Incentive Plan*

 

InJanuary 2003, the Board of Directors of Group approved the adoption of the2003 Equity Incentive Plan. Under the terms of the 2003 Plan, an aggregate of4,798,160 shares of common stock are available for award to key employees andconsultants in the form of non-qualified stock options and restricted shares,as follows:

 

•                                          1,115,812shares are reserved for the issuance of stock options at an exercise price of$6.82 or fair market value, whichever is greater;

 

•                                          1,115,812shares are reserved for the issuance of stock options at an exercise price of$25.00 or fair market value, whichever is greater;

 

•                                          1,115,812shares are reserved for the issuance of stock options at an exercise price of$35.00 or fair market value, whichever is greater;

 

•                                          1,450,724shares are reserved for the issuance of restricted shares.

 

The optionshave terms of ten years and become exercisable over the period provided in eachgrant agreement.

 

A summary ofstock option activity for the three years ended January 31, 2004, is asfollows:

 
| ** **                         | ** ** | **2003**   | ** ** | **2002**                              | ** ** | **2001**   | ** ** |
|------------------------------------|------------|------------|------------|---------------------------------------|------------|------------|------------|
| ** **                         | ** ** | **Shares** | ** ** | **Weighted  average  exercise price** | ** ** | **Shares** | ** ** | **Weighted  average  exercise price** | ** ** | **Shares** | ** ** | **Weighted  average  exercise price** | ** ** |
|                               |       |       |       |                                  |       |       |       |   |   |   |   |   |   |
| Outstanding, beginning of year     |       | 4,474,469  |       | $                                     | 18.22      |       | 1,808,790  |   | $ | 9.97 |   | 1,788,750 |   | $ | 9.15 |   |
| Granted                            |       | 377,750    |       | 6.85                                  |       | 3,263,239  |       | 21.35 |   | 283,000 |   | 14.53 |   |
| Exercised                          |       | —     |       | —                                |       | —     |       | — |   | — |   | — |   |
| Cancelled                          |       | (2,441,613 | )          | 26.19                                 |       | (597,560   | )          | $ | 10.29 |   | (262,960 | ) | 9.31 |   |
|                               |       |       |       |                                  |       |       |       |   |   |   |   |   |   |
| Outstanding, end of year           |       | 2,410,606  |       | $                                     | 8.37       |       | 4,474,469  |   | $ | 18.22 |   | 1,808,790 |   | $ | 9.97 |   |
|                               |       |       |       |                                  |       |       |       |   |   |   |   |   |   |
| Options exercisable at end of year |       | 849,302    |       | $                                     | 10.59      |       | 842,340    |   | $ | 9.81 |   | 728,950 |   | $ | 9.21 |   |

 

The following table summarizes informationabout stock options outstanding as of January 31, 2004.

 
| ** **         | ** ** | **Outstanding**        | ** ** | **Weighted  average**               | ** ** | **Exercisable**                              | ** ** |
|--------------------|------------|------------------------|------------|-------------------------------------|------------|----------------------------------------------|------------|
| **Range**          | ** ** | **Number of  options** | ** ** | **Weighted  average  option price** | ** ** | **remaining  contractual life  (in months)** | ** ** | **Number of  options** | ** ** | **Weighted  average  option price** | ** ** |
|               |       |                   |       |                                |       |                                         |       |   |   |   |   |
| $6.82—$8.53   |       | 1,798,240              |       | $                                   | 6.85       |                                         | 94         |   | 342,736 |   | $ | 6.98 |   |
| $10.00—$35.00 |       | 612,366                |       | 12.83                               |       | 70                                           |       | 506,566 |   | 13.03 |   |
|               |       |                   |       |                                |       |                                         |       |   |   |   |   |
| $6.82—$35.00  |       | 2,410,606              |       | $                                   | 8.37       |                                         | 88         |   | 849,302 |   | $ | 10.59 |   |

 

F-28

----

 

Under the 2003Plan 1,004,266 and 224,402 restricted shares were issued in fiscal 2002 and2003 and 83,689 restricted shares were forfeited in fiscal 2003. The fair valueof the restricted stock at date of issuance was $0.74 per share.

 

**(16)  Recent Accounting Pronouncements**

 

In April 2003,the FASB issued **SFAS No. 149, “Amendmentof Statement 133 on Derivative Instruments and Hedging Activities.”**This statement amends and clarifies financial accounting and reporting forderivative instruments, including certain derivative instruments embedded inother contracts and for hedging activities under FASB Statement No. 133,“Accounting for Derivative Instruments and Hedging Activities.” The provisionsof this statement are effective for contracts entered into or modified afterJune 30, 2003 and hedging relationships designated after June 30,2003. The provisions of the statement related to Statement 133Implementation Issues that have been effective for fiscal quarters that beganprior to June 15, 2003 should continue to be applied in accordance withtheir respective effective dates. The adoption of SFAS No. 149 did nothave a significant effect on our financial statements.

 

In May 2003,the FASB issued **SFAS No. 150,“Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity.”** This statement establishes standards forhow an issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. It requires that an issuerclassify a financial instrument that is within its scope as a liability (or anasset in some circumstances). Many of those instruments were previouslyclassified as equity. The provisions of this statement were effective at thebeginning of the first interim period beginning after June 15, 2003. Theadoption of SFAS No. 150 resulted in a reclassification of the liquidationvalue and accumulated and unpaid dividends of the Series B preferred stockand the accumulated and unpaid dividends related to the Series A preferredstock to liabilities, which totaled $211.7 million as of January 31,2004. After such reclassification, the dividends related to the Series Bpreferred stock and the accreted dividends of the Series A Preferred Stockwill be treated as interest expense.

 

In December2003, the FASB revised and reissued **FASB InterpretationNo. 46, “Consolidation of Variable Interest Entities.”** FINNo. 46 requires unconsolidated variable interest entities to beconsolidated by their primary beneficiaries if the entities do not effectivelydispense the risks and rewards of ownership among their owners and otherparties involved. The provisions of FIN No. 46 must be applied no laterthan as of the end of the first reporting period ending after March 15,2004. The adoption of FASB Interpretation No. 46 will not have asignificant effect on our financial statements.

 

**(17)  Quarterly Financial Information (Unaudited)**

 
| ** **                              | ** ** | **(in millions)**              | ** ** |
|-----------------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **13 weeks  ended  5/4/02(a)** | ** ** | **13 weeks  ended  8/3/02** | ** ** | **13 weeks  ended  11/2/02** | ** ** | **13 weeks  ended  2/1/03(b)** | ** ** | **52 weeks  ended  2/1/03** | ** ** |
|                                    |       |                           |       |   |   |   |   |   |   |   |   |
| Net sales                               |       | $                              | 157.9      |   | $ | 160.9 |   | $ | 181.9 |   | $ | 231.6 |   | $ | 732.3 |   |
| Gross profit(d)                         |       | 69.2                           |       | 63.0 |   | 77.9 |   | 86.0 |   | 296.1 |   |
| Net loss Group                          |       |                                | (12.1      | ) |  | (7.1 | ) |  | (0.7 | ) |  | (20.7 | ) |  | (40.6 | ) |
| Net  income (loss)  Operating Corp |       | (9.2                           | )          | (4.1 | ) | 2.1 |   | 2.4 |   | (8.8 | ) |

 
| ** **                         | ** ** | **13 weeks  ended  5/3/03** | ** ** | **13 weeks  ended  8/2/03(c)** | ** ** | **13 weeks  ended  11/1/03** | ** ** | **13 weeks  ended  1/31/04** | ** ** | **52 weeks  ended  1/31/04** | ** ** |
|------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|
|                               |       | ** **                  | ** ** | ****                           | ** ** | ** **                   | ** ** | ****                         | ** ** | ** **                   | ** ** |
| **As reported:**                   |       |                        |       |                           |       |                         |       |                         |       |                         |       |
| Net sales                          |       | $                           | 152.6      |                           | $          | 159.2                        |       | $                            | 146.4      |                         | $          | 202.4 |   | $ | 660.6 |   |
| Gross  profit(d)                   |       | 58.5                        |       | 51.5                           |       | 60.9                         |       | 81.7                         |       | 252.6                        |       |
| Net  income (loss) Group           |       | (19.6                       | )          | 15.2                           |       | (23.6                        | )          | (19.3                        | )          | (47.3                        | )          |
| Net  income (loss) Intermediate    |       | (14.9                       | )          | 24.1                           |       | (11.9                        | )          | (1.4                         | )          | (4.1                         | )          |
| Net income (loss)  Operating Corp  |       | (14.9                       | )          | (17.8                          | )          | (8.3                         | )          | 1.9                          |       | (39.1                        | )          |
|                               |       |                        |       |                           |       |                         |       |                         |       |                         |       |
| **As restated:****(e)**            |       |                        |       |                           |       |                         |       |                         |       |                         |       |
| Net sales                          |       | $                           | 152.6      |                           | $          | 159.2                        |       | $                            | 146.4      |                         | $          | 202.4 |   | $ | 660.6 |   |
| Gross profit                       |       | 57.8                        |       | 51.3                           |       | 60.0                         |       | 80.6                         |       | 249.7                        |       |
| Net income  (loss)  Group     |       | (20.3                       | )          | 15.0                           |       | (24.5                        | )          | (20.4                        | )          | (50.2                        | )          |
| Net income  (loss)  Intermediate   |       | (15.5                       | )          | 23.9                           |       | (12.8                        | )          | (2.6                         | )          | (7.0                         | )          |
| Net income  (loss)  Operating Corp |       | (15.5                       | )          | (18.0                          | )          | (9.2                         | )          | .7                           |       | (42.0                        | )          |

 

----

(a)                                  Netloss includes a pre-tax charge of $4.6 million related to severance costsfor approximately 120 employees and the departure of Mark Sarvary, a formerChief Executive Officer in April 2002. The staff reductions occurred inthe first quarter of fiscal 2002 and the related payments were incurredprimarily in the second quarter of fiscal 2002.

 

(b)                                 Netloss includes (a) pre-tax charges of $7.7 million related toseverance costs and other one-time employment related expenses, primarilyrelating to the terminations of several executive employees, the termination ofemployment of Kenneth Pilot, a former Chief Executive Officer inJanuary 2003 and a non-recoverable employment bonus for the Company’s newPresident, Jeffrey Pfeifle, (b) $1.8 million to write-off deferredfinancing charges in connection with the refinancing of our credit facility(c) a $9 million

 

F-29

----

 

inventorywritedown as a result of the Company’s decision to modify its strategy on thedisposition of inventory to accelerate inventory clearing at the end of eachselling season and (d) a tax provision of $6.5 million on a pre-taxloss of $14.2 million as a result of providing a valuation allowanceagainst deferred tax assets at February 1, 2003.

 

(c)                                  Netincome includes a pre-tax gain on the exchange of debt of $41.1 million.

 

(d)                                 Amounts previously reported havebeen reclassified to conform to current years presentation.

 

(e)                                  Amountspreviously reported have been restated (Seenote 2 to the consolidated financial statements for a description of therestatement).

 

F-30

----

 

**SCHEDULE II VALUATION AND QUALIFYINGACCOUNTS**

 
| ** **                                                           | ** ** | **beginning  balance** | ** ** | **charged to  cost and  expenses** | ** ** | **charged to other  accounts** | ** ** | **deductions** | ** ** | **ending  balance** | ** ** |
|----------------------------------------------------------------------|------------|------------------------|------------|------------------------------------|------------|--------------------------------|------------|----------------|------------|---------------------|------------|
| ** **                                                           | ** ** | **($in thousands)**    | ** ** |
|                                                                 |       |                   |       |                               |       |                           |            |           |       |                |       |
| *Inventory reserve*(deducted from inventories)                       |       |                   |       |                               |       |                           |       |           |       |                |       |
| fiscal year ended:                                                   |       |                   |       |                               |       |                           |       |           |       |                |       |
| January 31, 2004                                                |       | $                      | 12,420     |                               | $          | —                         | (a)        | $              | —     | (a)                 | $          | 7,380 | (a) | $ | 5,040 |   |
| February 1, 2003                                                |       | 8,367                  |       | 4,053                              | (a)        | —                         |       | —         |       | 12,420              |       |
| February 2, 2002                                                |       | 7,360                  |       | 1,007                              | (a)        | —                         |       | —         |       | 8,367               |       |
| *Allowance for sales returns*(included in other current liabilities) |       |                   |       |                               |       |                           |       |           |       |                |       |
| fiscal year ended:                                                   |       |                   |       |                               |       |                           |       |           |       |                |       |
| January 31, 2004                                                |       | $                      | 5,313      |                               | $          | —                         | (a)        | $              | —     | (a)                 | $          | 2,309 | (a) | $ | 3,004 |   |
| February 1, 2003                                                |       | 6,475                  |       | (1,162                             | )(a)       | —                         |       | —         |       | 5,313               |       |
| February 2, 2002                                                |       | 6,530                  |       | (55                                | )(a)       | —                         |       | —         |       | 6,475               |       |
|                                                                      |            |                        |            |                                    |            |                                |            |                |            |                     |            |  |  |  |  |  |  |

 

----

(a)                                  Theinventory reserve and allowance for sales returns are evaluated at the end ofeach fiscal quarter and adjusted (plus or minus) based on the quarterlyevaluation. During each period inventory write-downs and sales returns arecharged to the statement of operations as incurred.

 

F-31

----