DRS 1 filename1.htm DRS S-1
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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

As submitted confidentially with the Securities and Exchange Commission on July 18, 2019

This draft registration statement has not been publicly filed with the Securities and Exchange Commission and all information herein remains strictly confidential.

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Chinos Holdings, Inc.*

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   5600   27-4173834

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

 

30-30 47th Ave

Long Island City, New York 11101

(718) 340-5701

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Libby Wadle

President and Chief Executive Officer

30-30 47th Ave

Long Island City, New York 11101

(718) 340-5701

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service)

 

 

Copies to:

 

Michael J. Aiello

Alexander D. Lynch

Weil, Gotshal & Manges LLP

767 Fifth Avenue

New York, New York 10153

(212) 310-8000 (Phone)

(212) 310-8007 (Fax)

 

Michael Benjamin

Stelios G. Saffos

Latham & Watkins LLP

885 Third Avenue

New York, New York 10022

Telephone: (212) 906-1200

Fax: (212) 751-4864

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

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

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided to Section 7(a)(2)(B) of the Securities Act.   ☐

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of
Securities to be Registered
 

Proposed

Maximum
Aggregate

Offering Price(1)(2)

  Amount of
Registration Fee

Common stock, $0.00001 par value per share

  $               $            

 

 

(1)

Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) promulgated under the Securities Act of 1933, as amended.

(2)

Includes shares of common stock that may be issuable upon exercise of an option to purchase additional shares granted to the underwriters. See “Other Information Related to This Offering—Underwriting.”

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

*

Chinos Holdings, Inc., the registrant whose name appears on the cover of this registration statement, is a Delaware corporation. Prior to the completion of this offering, Chinos Holdings, Inc. will change its name to Madewell Group, Inc. Shares of the common stock of Madewell Group, Inc. are being offered by the prospectus.

 

 

 


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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion, Dated                 , 2019

PRELIMINARY PROSPECTUS

 

 

LOGO

Chinos Holdings, Inc.

Common Stock

 

 

This is an initial public offering of common stock by Chinos Holdings, Inc. (to be renamed Madewell Group, Inc. prior to the completion of this offering). We are offering              shares of our common stock.

Prior to this offering, there has been no public market for our common stock. It is currently estimated that the initial public offering price per share will be between $         and $        . We intend to apply to have our common stock listed on the New York Stock Exchange (“NYSE”) or NASDAQ Global Market (“NASDAQ”) under the symbol “                .”

Investing in our common stock involves risk. See “Risk Factors” beginning on page 23 to read about factors you should consider before buying shares of our common stock.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

    

Per Share

      

Total

 

Initial public offering price

   $          $    

Underwriting discounts and commissions(1)

   $          $    

Proceeds to us, before expenses

   $          $    

 

  (1)

We have agreed to reimburse the underwriters for certain expenses in connection with this offering. See “Other Information Related to This Offering—Underwriting,” beginning on page 180 of this prospectus, for additional information regarding total underwriter compensation.

We have granted the underwriters an option to purchase up to an additional                  shares of common stock from us at the initial public offering price less the underwriting discounts and commissions, for 30 days after the date of this prospectus.

The underwriters expect to deliver the shares to investors against payment in New York, New York on or about                 , 2019.

 

 

Prospectus dated                    , 2019.


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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

TABLE OF CONTENTS

 

    

Page

 

PROSPECTUS SUMMARY

     1  

RISK FACTORS

     23  

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

     51  

THE REORGANIZATION

     53  

USE OF PROCEEDS

     54  

DIVIDEND POLICY

     55  

CAPITALIZATION

     56  

DILUTION

     58  

ADDITIONAL INFORMATION RELATED TO CHINOS HOLDINGS

     60  

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA OF CHINOS HOLDINGS

     61  

UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL DATA OF CHINOS HOLDINGS

     63  

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF CHINOS HOLDINGS

     68  

CHINOS HOLDINGS BUSINESS

     87  

CHINOS HOLDINGS MANAGEMENT

     91  

CHINOS HOLDINGS EXECUTIVE COMPENSATION

     95  

DESCRIPTION OF CERTAIN INDEBTEDNESS OF CHINOS HOLDINGS

     119  

ADDITIONAL INFORMATION RELATED TO THE MADEWELL BUSINESS

     120  

SUPPLEMENTAL SELECTED HISTORICAL COMBINED FINANCIAL DATA OF THE MADEWELL BUSINESS

     121  

SUPPLEMENTAL MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE MADEWELL BUSINESS

     123  

MADEWELL BUSINESS

     140  

MADEWELL MANAGEMENT

     162  

MADEWELL COMPENSATION

     165  

DESCRIPTION OF MATERIAL INDEBTEDNESS OF MADEWELL

     166  

OTHER INFORMATION RELATED TO THIS OFFERING

     167  

PRINCIPAL STOCKHOLDERS

     168  

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     169  

DESCRIPTION OF CAPITAL STOCK

     172  

SHARES ELIGIBLE FOR FUTURE SALE

     174  

MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS FOR NON-U.S. HOLDERS

     176  

UNDERWRITING

     180  

LEGAL MATTERS

     186  

EXPERTS

     186  

WHERE YOU CAN FIND MORE INFORMATION

     186  

INDEX TO FINANCIAL STATEMENTS

     F-1  

 

 

You should rely only on the information contained in this prospectus or in any free-writing prospectus we may specifically authorize to be delivered or made available to you. Neither we nor the underwriters (or any of our or their respective affiliates) have authorized anyone to provide any information other than that contained in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we have referred you. Neither we nor the underwriters (or any of our or their respective affiliates) take any responsibility for, and neither we nor they provide any assurance as to the reliability of, any other information that others may give you. We and the underwriters (or any of our or their respective affiliates) are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus or any free-writing prospectus is only accurate as of its date, regardless of its time of delivery or the time of any sale of shares of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

Background

Prior to the completion of this offering, we intend to change our corporate name from Chinos Holdings, Inc. to Madewell Group, Inc.

Chinos Holdings, Inc. (“Chinos Holdings”), a Delaware corporation, is a holding company that, prior to this offering, was the ultimate parent of various subsidiaries that operate (i) the Madewell brand clothing retail business (the “Madewell business”) and (ii) the J.Crew brand clothing retail business (the “J.Crew business”).

Concurrent with the completion of this offering, Chinos Holdings will undergo a series of transactions pursuant to which it will:

 

   

spinoff the J.Crew business to its stockholders (the “Separation”), after which (i) the J.Crew business will cease to be a part of Chinos Holdings and (ii) certain pre-Separation indebtedness of Chinos Holdings will be an obligation of the J.Crew business and will not be an obligation of Chinos Holdings on a consolidated basis;

 

   

enter into a transition services agreement (the “Transition Services Agreement”) and other related agreements, pursuant to which entities operating the J.Crew business will continue to provide us with certain administrative capabilities for a specified period of time following the Separation;

 

   

exchange shares of its common stock for certain of its pre-Separation indebtedness;

 

   

incur new debt obligations and use the net proceeds it receives therefrom together with the proceeds from this offering to repay its remaining pre-Separation indebtedness; and

 

   

convert its preferred stock into common stock.

We refer to these transactions, together with this offering, collectively as the “Reorganization.” See “The Reorganization” and “Other Information Related to This Offering—Certain Relationships and Related Party Transactions—Relationship with J.Crew.”

After the Reorganization, Chinos Holdings will no longer directly or indirectly own or operate the J.Crew business and the only business of Chinos Holdings will be the Madewell business. Accordingly, the Madewell business is the business in which you are investing if you buy shares of common stock in this offering. In addition, Chinos Holdings will not be an obligor or guarantor of, or have any asset pledged as collateral for, any of its pre-Reorganization indebtedness after the Reorganization.

Unless the context requires otherwise, for periods prior to the Reorganization:

 

   

references to “Madewell,” the “Company,” “we,” “us” or “our” refer to the Madewell business that will remain with Chinos Holdings after the Reorganization and does not refer to the J.Crew business;

 

   

references to “Chinos Holdings” refer to Chinos Holdings, Inc. (which will be renamed Madewell Group, Inc. prior to the completion of this offering) and its consolidated subsidiaries that collectively operate the Madewell business and the J.Crew business prior to the Reorganization;

 

   

references to “J.Crew” refer to the J.Crew business that will be spun off from Chinos Holdings in the Separation; and

 

   

references to “J.Crew Group” refer to J.Crew Group, Inc., an indirect subsidiary of Chinos Holdings, and its subsidiaries on a consolidated basis, which collectively operate both the Madewell

 

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business and the J.Crew business prior to the Reorganization. The J.Crew Group will be included in the spinoff of the J.Crew business and will no longer be a subsidiary of Chinos Holdings or own or operate the Madewell business after the Reorganization.

Unless the context requires otherwise, for periods following the Reorganization:

 

   

references to “Madewell,” the “Company,” “we,” “us” or “our” refer to Chinos Holdings and its subsidiaries after giving effect to the Reorganization;

 

   

references to “J.Crew Group” refer to J.Crew Group, Inc., and its subsidiaries on a consolidated basis, which collectively operate the J.Crew business; and

 

   

references to “J.Crew” refer to the companies operating the J.Crew business after giving effect to the Reorganization.

Basis of Financial Presentation

In this prospectus we present historical consolidated financial statements of Chinos Holdings and supplemental historical combined financial statements for the Madewell business.

The historical consolidated financial statements of Chinos Holdings include the Madewell business and the J.Crew business that will be spun off pursuant to the Separation and do not give effect to the Reorganization transactions. The historical results of operations, financial condition and cash flows of Chinos Holdings will not be comparable to our results of operations, financial condition and cash flows following the Reorganization.

The supplemental historical combined financial statements of the Madewell business have been derived from Chinos Holdings’ consolidated financial statements and accounting records and represent the financial condition and results of operations of the Madewell business on a carveout basis, prepared in accordance with U.S. GAAP. The supplemental historical combined financial statements of the Madewell business reflect the financial position, results of operations and cash flows of the Madewell business which will be the only operating business that will remain with us after the Reorganization, do not give effect to the other transactions in the Reorganization and do not purport to reflect what the results of operations, financial condition and cash flows would have been had we operated the Madewell business as a standalone, publicly traded company during the periods presented or for future periods. The supplemental historical combined financial statements of the Madewell business do not reflect the J.Crew business or the historical consolidated financial statements of Chinos Holdings.

The J.Crew business currently provides certain services to the Madewell business, and the supplemental historical combined financial statements of the Madewell business reflect an allocation of certain Chinos Holdings corporate costs, including, among others, finance, information technology, human resources, corporate occupancy, legal, production and sourcing, supply chain, store and e-commerce operations and executive leadership (“Allocated Costs”). Allocated Costs are not necessarily indicative of the expenses that we will incur under the Transition Services Agreement, or that we would have incurred or we may incur in the future if we were operating the Madewell business as a standalone, publicly traded company. The amount and composition of our expenses may vary from historical levels since the fees charged for the services under the Transition Services Agreement may be higher or lower than the Allocated Costs. In addition, we intend to replace these services over time with ones supplied either internally by our employees or by third parties, the cost of which may be higher or lower than the Allocated Costs. The difference between the Allocated Costs and the costs we will incur under the Transition Services Agreement or that we will incur as we replace these services and after the expiration of the Transition Services Agreement may be material.

Allocated Costs are included in the supplemental historical combined statements of income of the Madewell business included herein if they are specifically identifiable to the Madewell business, or are allocated

 

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using a systematic and rational allocation method, most commonly using percent of revenues or percent of employee headcount. The supplemental historical combined balance sheets of the Madewell business included herein reflect all of the assets and liabilities that are specifically identifiable to the Madewell business or directly attributable to the Madewell business as a carved out company and its operations. Not all of the cash generated by the Madewell business is included on the supplemental historical combined balance sheets of the Madewell business included herein as cash is swept into the consolidated bank accounts of Chinos Holdings pursuant to its centralized cash management function. The cash sweep process will not continue after the Reorganization. Obligations resulting from liabilities of the Madewell business are paid with cash from Chinos Holdings. The intercompany effect of these cash transactions is reflected in Due to Parent in the supplemental historical combined balance sheets of the Madewell business. The supplemental historical combined financial statements of the Madewell business do not include an allocation of debt or interest expense from Chinos Holdings because the Madewell business is not considered the obligor of such debt for accounting purposes and because the borrowings were not directly attributable to the Madewell business. The supplemental historical combined balance sheets of the Madewell business and the combined statements of changes in stockholders’ equity of the Madewell business do not reflect the historical equity capitalization of Chinos Holdings, including the common and preferred stock that will be recapitalized in the Reorganization. Unless the context otherwise requires, references in this prospectus to “common stock” and “preferred stock” refer to the common and preferred stock of Chinos Holdings after giving effect to the Reorganization. See “Additional Information Related to the Madewell Business—Supplemental Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Madewell Business,” “Other Information Related to This Offering—Certain Relationships and Related Party Transactions” and Note 2: Allocated Costs in the notes to the supplemental historical combined financial statements of the Madewell business for additional details on the Allocated Costs.

This prospectus also contains unaudited pro forma consolidated financial statements that have been developed by applying pro forma adjustments to the historical consolidated financial statements of Chinos Holdings. The unaudited pro forma consolidated statements of income for the year ended February 2, 2019 gives pro forma effect to certain Reorganization transactions as if they had occurred on February 4, 2018. The unaudited pro forma consolidated balance sheet as of February 2, 2019 gives pro forma effect to certain Reorganization transactions as if they had occurred on February 2, 2019. All pro forma adjustments and underlying assumptions are described more fully in the notes to the unaudited pro forma consolidated financial statements included in this prospectus.

The fiscal years of Chinos Holdings and the Madewell business end on the Saturday closest to January 31, typically resulting in a 52-week year, but occasionally includes an additional week, resulting in a 53-week year. All references to fiscal 2018 reflect the results of the 52-week period ended February 2, 2019; all references to fiscal 2017 reflect the results of the 53-week period ended February 3, 2018; and all references to fiscal 2016 reflect the results of the 52-week period ended January 28, 2017. In addition, all references to fiscal 2019 reflect the 52-week period ending February 1, 2020.

J.Crew Group is a voluntary filer of periodic reports with the Securities and Exchange Commission (the “SEC”). The historical results of operations, financial condition and cash flows of Chinos Holdings may not be comparable to the historical results of operations, financial condition and cash flows of J.Crew Group included in its periodic reports.

Non-U.S. GAAP Financial Measure

We provide the non-U.S. GAAP measure Adjusted EBITDA for the Madewell business in this prospectus. Adjusted EBITDA is a key performance indicator used by management of the Madewell business and typically used by competitors in the specialty retail industry, but is not recognized under U.S. GAAP.

Adjusted EBITDA is defined as combined net income of the Madewell business before depreciation and amortization, interest expense and provision for income taxes adjusted for the impact of certain items, including

 

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non-cash and other items that are not considered representative of its ongoing operating performance. Because Adjusted EBITDA omits these items, management of the Madewell business feels that it is less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges.

Adjusted EBITDA is a supplemental measure of the operating performance of the Madewell business that is neither required by, nor presented in accordance with, U.S. GAAP and the calculations thereof may not be comparable to those reported by other companies. We present Adjusted EBITDA as we believe it is frequently used by securities analysts, investors and other interested parties to evaluate companies in the specialty retail industry and management uses it internally as a benchmark to compare the performance of the Madewell business to that of its competitors. The presentation of Adjusted EBITDA of the Madewell business should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.

We believe Adjusted EBITDA is a useful measure of the operating performance of the Madewell business, as it provides a clearer picture of the results of operations of the Madewell business by eliminating expenses that are not reflective of underlying business performance. We use Adjusted EBITDA to monitor the performance of the Madewell business and we believe the presentation of this measure will enhance the ability of investors to analyze trends in the Madewell business and evaluate the performance of the Madewell business relative to other companies in the industry. However, Adjusted EBITDA is a non-U.S. GAAP financial measure that has limitations as an analytical tool. Some such limitations are:

 

   

it does not reflect the interest expense, or the cash requirements necessary to service interest or principal payments on any outstanding debt;

 

   

it does not reflect our tax expense or the cash requirements to pay taxes;

 

   

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future and Adjusted EBITDA does not reflect any cash requirements for such replacements;

 

   

it is not adjusted for all non-cash income or expense items that are reflected in statements of cash flows of the Madewell business;

 

   

the further adjustments made in calculating Adjusted EBITDA are those that the management of the Madewell business consider are not representative of the underlying operations and therefore are subjective in nature;

 

   

Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure;

 

   

it does not reflect future requirements for capital expenditures or contractual commitments; and

 

   

it does not reflect changes in, or cash requirements for, working capital needs.

Adjusted EBITDA should not be considered as an alternative to, or substitute for, net income, which is calculated in accordance with U.S. GAAP. For Adjusted EBITDA of the Madewell business for the fiscal years 2018, 2017 and 2016, and a reconciliation of Adjusted EBITDA to net income, the most directly comparable U.S. GAAP measure, see “Prospectus Summary—Supplemental Summary Historical Combined Financial Data of the Madewell Business.”

Trademarks and Trade Names

Prior to the Reorganization, Chinos Holdings owns or has to the rights to various trademarks, trade names and service marks, including J.Crew® and Madewell® and various logos used in association therewith.

 

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After the Reorganization, we and our subsidiaries will own or have the rights to various trademarks, trade names and service marks, including Madewell® and various logos used in association with the Madewell business, and the entities operating the J.Crew business will continue to own or have rights to the trademarks, trade names, service marks and logos necessary to operate the J.Crew business. After the Reorganization, we will no longer own the trademarks and logos used in association with the J.Crew business. Solely for convenience, the trademarks, trade names and service marks and copyrights referred to herein are listed without the ©, ® and symbols, but such references are not intended to indicate, in any way, that the applicable owner will not assert, to the fullest extent under applicable law, its rights to these trademarks, trade names and service marks. Other trademarks, service marks or trade names appearing in this prospectus are the property of their respective owners.

Market and Industry Information

Unless otherwise indicated, market data and industry information used throughout this prospectus is based on the management of Chinos Holdings’ knowledge of the industry and good faith estimates. Additionally, in this prospectus we refer to a brand tracking study conducted by J.Crew in 2019 (the “Brand Tracking Study”) as the basis for certain statements. The Brand Tracking Study consisted of a 20-minute online, quantitative, blind market research survey of what management believes to be a nationally representative sample of shoppers in Madewell’s target demographic, conducted from January 16th to February 4th, 2019 and consisting of 3,167 total respondents.

We also relied, to the extent available, upon management’s review of independent industry surveys and publications and other publicly available information prepared by a number of sources. All of the market data and industry information used in this prospectus involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. Although we believe that these sources are reliable, neither we nor the underwriters (or any of our or their respective affiliates) can guarantee the accuracy or completeness of this information, and neither we nor the underwriters (or any of our or their respective affiliates) have independently verified his information. While we believe the estimated market position, market opportunity and market size information included in this prospectus is generally reliable, such information, which is derived in part from management’s estimates and beliefs, is inherently uncertain and imprecise. Projections, assumptions and estimates of our future performance and the future performance of the industry in which we operate are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors,” “Cautionary Note Regarding Forward-Looking Statements,” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in our estimates and beliefs and in the estimates prepared by independent parties.

Certain Market Terms

As used in this prospectus, references to these terms shall take the following meanings, unless otherwise indicated or the context otherwise requires:

 

   

“active customer” means any customer that has made a purchase of any Madewell product within a rolling 12-month period;

 

   

“comparable company sales” means (i) store net sales for stores that have been open for at least 12 months and (ii) e-commerce net sales, including shipping and handling fees. Comparable company sales exclude net sales from: (i) new stores that have not been open for 12 months, (ii) the 53rd week, if applicable, (iii) stores that experience a square footage change of at least 15 percent, (iv) stores that have been temporarily closed for at least 30 consecutive days, (v) permanently closed stores, (vi) temporary “pop up” stores and (vii) revenue from wholesale customers;

 

   

“dot-com try-ons” means our in-store “showrooming” program that allows customers to try on samples of various styles and sizes of Madewell products at retail stores that are then purchased and shipped to the customer via the ecommerce platform. These “dot-com try-on” samples are not available to purchase in-store;

 

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“direct to consumer” or “DTC” means channels directly connecting Madewell to customers without the use of an intermediary and includes our e-commerce and store channels but not our wholesale channel;

 

   

“new-to-brand customers” means customers who purchased Madewell products for the first time;

 

   

“omnichannel” means the integration of the multiple direct-to-consumer channels through which customers interact and purchase with the Madewell brand including stores, Madewell.com (desktop and mobile) and our customer call center, but excluding wholesale;

 

   

“returning customers” means customers that purchased Madewell products through any DTC channel in fiscal 2018 that also purchased Madewell products through any DTC channel in fiscal 2017; and

 

   

“sales per selling square foot” means store sales divided by total selling square footage of such stores.

Additionally, as used in this prospectus, references to the following metrics used in relation to the Brand Tracking Study shall take the following meanings:

 

   

brand “affinity” means the average response of Brand Tracker Survey respondents that are aware (see definition below) of the Madewell brand when asked how they feel about the Madewell brand on a scale of dislike to love and a “high” affinity means that the average response for the Madewell brand had a higher affinity score than the average affinity score of the comparative brands cited in the Brand Tracking Study of which respondents were aware;

 

   

“brand awareness” means responses were received from Brand Tracker Survey respondents that indicated such respondents had at least heard of the Madewell brand when asked how familiar they are with the Madewell brand; and

 

   

“purchase intent” means responses were received from Brand Tracker Survey respondents that were “aware” of the Madewell brand that indicated such respondents would at least consider Madewell for their next clothing purchases when asked how likely they are to consider choosing Madewell the next time they buy clothing for themselves.

 

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PROSPECTUS SUMMARY

This summary highlights selected information contained elsewhere in this prospectus. This summary primarily highlights selected information regarding the Madewell business, as the J.Crew business will be spun off in the Reorganization and our only business after this offering will be the Madewell business. The Madewell business is the business in which you are investing by buying shares of common stock in this offering. Financial and other operating data of the Madewell business set forth in this “Prospectus Summary” and the “Additional Information Related to the Madewell Business—Madewell Business” is provided on a carveout basis for the periods presented, unless the context otherwise requires. This summary does not contain all the information you should consider before buying shares in this offering. Therefore, you should read this entire prospectus carefully, including the sections titled “Risk Factors,” “Additional Information Related to the Madewell Business—Supplemental Selected Historical Combined Financial Data of the Madewell Business,” the historical consolidated financial statements of Chinos Holdings and the related notes included elsewhere in this prospectus and the supplemental historical combined financial statements of the Madewell business and the related notes supplementally provided elsewhere in this prospectus before deciding whether to purchase our common stock. Unless the context requires otherwise, the words “we,” “us,” “our,” the “Company” and “Madewell” in “Prospectus Summary” refer to the Madewell business.

 

 

LOGO

Who We Are

Madewell is a fast-growing and innovative brand offering a full product assortment rooted in premium denim and everything you wear with jeans—cool tees, cozy sweaters, comfy sneakers, timeless leather jackets, totes, tops and much more. We also offer lifestyle products including dresses, swimwear, beauty, gifts, jewelry and sunglasses. Madewell offers a cool, unexpected and artful aesthetic that feels timeless, effortless and relevant in today’s era of self-expression.

Our brand appeals to a broad demographic, especially to millennials, by offering well-designed products, premium quality at non-premium prices and inspiring and engaging content while valuing inclusivity and sustainability. We believe our ability to deliver on all of these elements allows us to stand apart.

We have developed a digitally-led, omnichannel strategy that puts the customer at the center, creates seamless touchpoints across channels and fosters community. E-commerce sales represented 37% of our DTC revenue in fiscal 2018. Our broad digital ecosystem—from our fully mobile-responsive e-commerce website and social media channels to in-store screens and associate tablets and our membership program, Madewell Insider—allows us to better connect, engage, track and service customers. This ecosystem also provides robust quantitative and qualitative customer data that we use to inform all aspects of our operations, from product development to merchandising and marketing. Our stores serve as local hubs for brand engagement, product education, fit and styling guidance, community-building and cross-channel service. We operated 129 stores in the United States as of February 2, 2019, most of which are located in upscale regional Class A malls, lifestyle centers and street locations, averaging approximately 3,400 square feet and generating an average of approximately $1,100 in sales per selling square foot in fiscal 2018. We also employ selective wholesale



 

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partnerships to introduce our brand to new customers and test new markets. Our customer-first strategy unifies all channels and enhances customer acquisition, retention, store productivity and customer lifetime value.

We acquired the Madewell brand in 2006 and taking inspiration from its American workwear roots, have built a relevant brand with strong customer affinity compared to industry peers. By engaging with our customers in a digitally-led way and focusing on our core values of community and responsible retailing, we have driven impressive growth over the past five years, as illustrated by the following significant milestones:

 

 

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We have grown revenue from $248 million in fiscal 2014 to $614 million in fiscal 2018, a four-year compound annual growth rate (“CAGR”) of 25%

 

   

We have grown active customers from 2.0 million in fiscal 2017 to 2.6 million in fiscal 2018, and in fiscal 2018, 60% of our active customers were in our membership program, Madewell Insider, representing 67% of DTC revenue

 

   

Our customers are very loyal, driving high customer lifetime value and efficient marketing spending, generating an attractive ratio of customer lifetime value to customer acquisition cost

 

   

We have grown e-commerce penetration from 26% of DTC revenue in fiscal 2014 to 37% in fiscal 2018

 

   

We have achieved positive comparable company sales growth in 40 of the last 41 quarters

 

   

We are highly profitable, with net income and Adjusted EBITDA margins of 10% and 18%, respectively, in fiscal 2018

 

   

We have collected and recycled over 600,000 pairs of jeans from customers, creating over one million square feet of housing insulation that has been donated to organizations such as Habitat for Humanity

For a reconciliation of Adjusted EBITDA to net income, see “—Supplemental Summary Historical Combined Financial Data of the Madewell Business.”



 

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Selected Financial Data of the Madewell Business

(Dollars in millions; active customers in millions)

 

LOGO    LOGO

 

LOGO

  

 

LOGO

Our Vision

We have a vision to be:

THE TOP PREMIUM DENIM AUTHORITY

AN INNOVATOR IN DIGITAL AND OMNICHANNEL RETAIL

A COMMUNITY THAT FOSTERS INCLUSIVITY AND LOYALTY

A LEADER IN SUSTAINABILITY

What We’re About

Artful and Timeless Lifestyle Brand Rooted in Denim

Madewell offers a cool, unexpected and artful aesthetic that feels timeless, effortless and relevant in today’s era of self-expression. We are a purpose driven brand utilizing a community-based marketing strategy to engage our customers through differentiated experiences and social impact initiatives. We believe that Good Days Start With Great Jeans and offer a full product assortment rooted in premium denim and everything you wear with jeans from easy tees and tops to perfect leather jackets, keep forever totes and much more. Our brand appeals to a broad demographic, especially millennials, by offering well-designed products, premium quality at non-premium prices and inspiring and engaging content, while valuing inclusivity and sustainability. Based on



 

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the Brand Tracking Study, 80% of those aware of Madewell would likely consider the brand for their next clothing purchase. In the same study, Madewell’s brand awareness was 45%. We believe our relatively low brand awareness, coupled with high affinity and purchase intent among existing customers, underscores a significant growth opportunity to convert potential new customers to loyal brand enthusiasts.

Superior Design Sensibility, Inclusive Assortment and Innovative Product Development

Madewell’s premium denim offering coupled with a full lifestyle assortment and fresh yet timeless aesthetic offers broad appeal. We have established strong design and product development capabilities in-house, including an independent, highly experienced denim design team. We are recognized for our creative capabilities, including our differentiated use of color, print and styling, to create a look that is both artful and effortless. We also utilize technical product innovation to elevate the comfort, fit and durability of our products. Our design and product development teams proactively and frequently incorporate customer feedback, both from over 125,000 product reviews and from our active customer panel—the Madewell Group Chat—a closed crowdsourcing forum we use to regularly communicate with approximately 4,400 customers who have volunteered to provide ongoing product and services feedback. We utilize promotions strategically to avoid training customers to buy on discount, driving strong full price sell through.

DENIM: BREADTH AND DEPTH OF FITS, SIZES AND WASHES

 

 

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Denim represented 29% of our revenue in fiscal 2018 and remains one of our highest growth categories. We believe a substantial portion of the population anchors their everyday wardrobes around denim—and not just for weekends but also increasingly for work and social occasions. We offer premium denim at non-premium prices, mostly in the $100-150 range, with our entry-level and popular Roadtripper jean, which we successfully introduced in 2017, starting at $75. We make exceptional jeans by partnering with premium denim mills, leveraging our expertise in washes and focusing on delivering superior quality through our attention to detail. We drive denim innovation by employing the latest in fabric technology, including reform stretch, fade-resistant black and proprietary sustainable fabrics. We also utilize fit technology and employ fit experts to offer products for many different shapes and sizes encompassing sizes 23-37 as well as petite, tall and taller inseams and styles that fit different body types. Denim is a high-performing category, as we consistently see a higher retention rate and lifetime value from denim purchasers.



 

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EVERYTHING YOU WEAR WITH JEANS: TEES, SHIRTS, JACKETS, FOOTWEAR, BAGS AND MORE

 

 

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For fiscal 2018, 52% of our revenue was attributable to “everything you wear with jeans.” Our key “everything you wear with jeans” categories include: tees, such as our essential Whisper Cotton tees; leather goods, such as our popular Transport Tote bag and vintage-inspired motorcycle jacket; footwear, such as our Sidewalk Sneaker with Cloudlift technology and Boardwalk sandals; cozy sweaters featuring our supersoft yarn; and a wide array of tops and button-down shirts featuring forward silhouettes and of-the-moment details.

For fiscal 2018, 19% of our revenue was attributable to lifestyle categories such as dresses, swimwear, beauty and gifts. We have also been recognized for our Labels We Love program featuring a curated assortment of third-party brands (including exclusive buys and collaborations), such as Outdoor Voices, Lively, Vans, Veja, Penfield, Sezane, Solid and Striped and many more. We regularly utilize insights from these collaborations to determine potential new product introductions, including the successful 2019 launches of our Second Wave sustainable swimwear collection made entirely of recycled materials and our first Madewell sneaker, the Sidewalk Sneaker.

LIFESTYLE: DRESSES, SWIMWEAR, BEAUTY, GIFTS AND MORE

 

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Digitally-Led Omnichannel Experience

We have developed a digitally-led, omnichannel strategy that puts the customer at the center and creates seamless touchpoints across channels. This customer-first strategy unifies our e-commerce and store businesses and enhances customer acquisition, retention, store productivity and customer lifetime value.

We have grown e-commerce revenue to represent 37% of total DTC revenue in fiscal 2018. In fiscal 2018, we migrated our website to a cloud-based, highly scalable and functionally-rich platform that allows us to



 

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innovate more rapidly, build out dynamic product presentation and expand personalization capabilities. We are hyper-focused on a seamless experience for our customer. Our website is fully mobile-responsive, offers a universal cart accessible across all of the customer’s devices, and provides visibility to e-commerce and store inventory with options for delivery or store pick-up. Our digital experience marries commerce and content by offering our customers access to our full product assortment, including exclusive styles and extended sizes, as well as providing an aesthetically rich shopping experience with compelling imagery, editorial stories, styling inspiration and fit guidance. Our website connects to a broad digital ecosystem—from our social media channels and email program to in-store screens and associate tablets, as well as our Madewell Insider membership program—allowing us to better connect, engage, track and service customers. This ecosystem also provides robust quantitative and qualitative customer data that we use to inform all aspects of our operations, from product development to merchandising and marketing.

Our stores remain core to our strategy. In fiscal 2018, over 60% of our new-to-brand customers made their first purchase in a store. Our store layouts have been thoughtfully designed to create a seamless shopping experience for our customers, especially for those trying to discover a perfect pair of jeans. Given the importance of discovery and trial as part of denim shopping experience, we position our Denim Bars and styling experts adjacent to our fitting rooms, which encourages supportive, spontaneous interactions between customers and our knowledgeable associates to provide fit and styling guidance. In addition, our stores serve as local hubs for brand engagement, product education, community-building and cross-channel service. We balance a high-touch, boutique feel in our stores with a sophisticated, digitized operation and omnichannel capabilities, including buy online and pickup in store, e-commerce returns, dot-com try-ons, early-stage testing of mobile point of sale (“POS”) and in-store digital screens. These capabilities enable us to service our customers seamlessly across established touchpoints and channels. In the twelve months ended April 19, 2019, 35% of customers who engaged with our stores for an e-commerce return made a new in-store purchase.

Our wholesale partnerships allow us to introduce our brand to new customers and test new markets. We do so by providing a curated offering across select wholesale partners. We launched our wholesale channel in 2015 with Nordstrom and have since experienced rapid growth through this partner. We have expanded our selective wholesale partnerships to include Net-a-Porter, Zalando and Shopbop.

The integration of stores and e-commerce is fundamental to our customer-first strategy and helping to create more loyal, omnichannel customers who spent more than 4.5 times what our single-channel customers spent in fiscal 2018. We utilize targeted marketing initiatives to acquire new customers and drive cross-channel migration.

A Community of Loyal Madewell Insiders and Advocates

We have developed a community-based marketing strategy by engaging with our customers through content and experiences across our digital platform, store footprint and events. Through these efforts, we have fostered a loyal and inclusive community and turned customers into brand advocates. Our store associates help drive our community efforts, acting as local shopkeepers, providing expert advice and driving community engagement through partnerships and events. We believe our community creates a strong network that results in lower customer acquisition costs and higher retention rates. Our initiatives include:

 

   

Madewell Insider: In fiscal 2018, 60% of our active customers were in our membership program, Madewell Insider, representing 67% of DTC revenue. The Madewell Insider profile is our customers’ passport to the Madewell brand and we engage and connect to our customers seamlessly through email, our mobile website, social media and store events. A Madewell Insider membership is centered around loyalty perks and rewards. Madewell Insider members represent our highest value customers, with nearly 80% of our $500+ spenders being a part of the membership program in fiscal 2018.



 

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Social Media: We encourage a dynamic and engaged digital community across social media, especially Instagram, Facebook, Twitter and Pinterest. We have a robust content creation operation and encourage two-way conversations. We have a strong social media following of approximately 2.4 million followers across these four platforms as of May 4, 2019. Our fans have engaged with one of our core brand hashtags (such as #everydaymadewell) over 14 million times on Instagram since 2012. This digital community is comprised of engaged, vocal champions of our brand, which we believe helps drive brand discovery and customer acquisition.

 

   

Madewell Group Chat: Our crowdsourcing platform, Madewell Group Chat, allows a pool of approximately 4,400 volunteer customers to interact with our brand and each other in a closed forum. It also creates a feedback loop that informs multiple aspects of our business from style feedback and product launches to services and social responsibility.

 

   

Hometown Heroes: Since 2010, we have welcomed our local community into our stores through the Hometown Heroes program, comprised of pop-ups with local makers and artists. This program gives local up-and-coming businesses the opportunity to introduce themselves to our customers, who in turn discover new brands and local talent. We encourage our store associates to be curators in their markets and to source makers that will resonate with their customers. This year we further emphasized the program by launching the Collective, in which we identify a group of our best makers from around the country and give them meaningful support to grow their businesses through mentorship, grants and access to our customer base.

 

   

Events: Our store events program is an important aspect of our engagement and retention strategy. In fiscal 2018, we hosted over 2,500 events, spanning pop-ups, panels, workshops and give-back events for local charities. In fiscal 2018, we evolved our events strategy by testing a new format and introducing Commons in Austin, Texas. The concept utilizes a flexible store design to execute a variety of larger-scale events and provides a platform for local makers and artwork. This location is a physical representation of our commitment to our in-store-experience.

Sustainability and Responsible Retailing

Sustainability is an integral part of our brand strategy. We strive to conduct our business in a manner that benefits our planet and inspires change in our industry. We are committed to being a business with purpose, where maximizing profitability and sustainability go hand in hand. To support this philosophy, we have created the Do Well program, a platform for us to articulate our sustainability goals and offer ways for our customers and associates to get involved in furthering these goals. We are evolving our practices by focusing on meaningful sustainability initiatives that influence the entire lifecycle of our products, from the materials we use to how we make them to how we encourage our customers to dispose of textile waste. Some of our tactics include our denim recycling program, incorporating sustainable and recycled fabrics into our products and fostering charitable partnerships that help us achieve and amplify our core values and sustainability goals.

Our denim recycling program continues to grow. In fiscal 2018, 12% of jeans sales were attributable to our denim recycling program and we have recycled over 600,000 pairs of jeans since initiating the program, creating over one million square feet of housing insulation that has been donated to organizations such as Habitat for Humanity. We are evolving the materials we use across all categories and are committed to incorporating sustainable and recycled fabrics into our products. We also launched our first Fair Trade Certified Denim Capsule in January 2019 and will continue expanding our sustainability efforts into other categories. In order to achieve and amplify our core values, we maintain strong partnerships with key charitable organizations.



 

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We believe our heightened focus on responsible retailing and sustainability is a key driver of brand engagement and helps our customers and associates connect with the Madewell brand.

 

LOGO

A Data Driven Approach that Guides our Success

We have developed strong data capture capabilities and we continually leverage our customer database and apply our insights to operate our business, acquire new customers and deepen relationships that increase customer lifetime value. With 2.6 million active customers in fiscal 2018 alone, we have built an extensive customer file that helps us drive actionable insights in product trends, style and fit opportunities and cross-channel shopping behavior and preferences. Data guides all aspects of our operations, including product assortment, inventory management, merchandising, marketing strategies, real estate choices and loyalty perks. We utilize “read and react” and scientific testing strategies on our website and in stores to test selected product offerings and quickly react to customer behavior. Our data-centric approach allows us to respond to customer preferences and mitigate risk, with a goal of improving our ability to provide consistent, predictable operating and financial performance over time.

Our digital marketing team is highly data driven. In fiscal 2018, we deployed an advanced marketing measurement system that enables a more sophisticated understanding of brand discovery and customer engagement across multiple marketing channels and drives greater efficiency of marketing spend. We utilized insights from our data in fiscal 2018 to accelerate customer acquisition, resulting in a significant increase in active customer growth with an increasing percentage driven by new e-commerce customers. Our efforts drove customer retention, largely fueled by our Madewell Insider membership program. Over 80% of returning customers in fiscal 2018 were members of Madewell Insider.

Experienced Leadership with Strong Track Record of Performance

Our leadership team is led by Libby Wadle, our President and Chief Executive Officer, who is a 23-year specialty retail industry veteran and has been a mentor to the Madewell brand since its initial launch in 2006. Ms. Wadle is responsible for driving Madewell’s strong financial results and developing its growth trajectory including its industry-leading digital performance. Her keen understanding of the specialty and e-commerce retail industry, high standards for responsible retailing, deep knowledge of our customer base and belief in the importance of building brand affinity have been honed over a career in senior merchandising and brand leadership roles at J.Crew, Coach and The Gap.

We have built a team from leading global organizations with significant industry experience and meaningful expertise in design, merchandising, marketing, retail and digital. We have developed a strong and collaborative culture centered on our goal of becoming the top premium denim authority while building a community and inspiring change in our industry.

How We Grow

Strengthen Brand Awareness and Acquire New Customers

We believe there is meaningful opportunity to grow our brand and build awareness in both existing and new markets. Based on the Brand Tracking Study, Madewell has brand awareness of 45%, though 80% of those



 

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aware would likely consider Madewell for their next clothing purchase. We intend to drive brand awareness by expanding our prospecting capabilities, extending mobile and video reach, expanding payment options, diversifying our advertising strategy and growing our store base. We are expanding our digital prospecting capabilities based on customer attributes, purchase intent signals and demographic data to broaden our marketing reach, while personalizing our messaging. Leveraging our strong video content creation capabilities, we are extending the use of video-to-social, mobile and online streaming platforms, such as Hulu and YouTube. Additionally, we will continue to grow our store base, where over 60% of our new-to-brand customers made their first purchase in fiscal 2018.

Madewell employs a digitally sophisticated marketing strategy focused on social media and content distribution, influencers and local and experiential marketing to drive brand awareness among new customers and increase the lifetime value of existing customers. In fiscal 2018, we accelerated our digital marketing investment, driving a significant increase in active customers with an increasing percentage driven by new e-commerce customers. We plan to continue similar strategies as employed in fiscal 2018 to grow the size and value of our active customer base across all channels. Through our targeted marketing investments and brand engagement, we believe we will continue to attract new customers to our brand and to convert single-channel customers to more profitable omnichannel customers, increasing overall customer retention and spend.

Enhance Customer Loyalty and Wallet Share

We launched our Madewell Insider membership program in fiscal 2016 and it has been a key driver of customer retention and purchase frequency. In fiscal 2018, 60% of our active customers were Madewell Insiders. They represented 67% of DTC revenue and over 80% of our returning customers. The Madewell Insider profile is our customers’ passport to the Madewell brand and we engage and connect to our customers seamlessly through email, our mobile website, social media and store events. Our Madewell Insider program is a tiered membership program centered around loyalty perks and rewards. We have three distinct Madewell Insider tiers, based on customer spend per calendar year, and our loyalty members receive loyalty perks such as free shipping, free personalization, early access to exclusive collaborations and invitations to special events, with our top tiers receiving additional benefits such as a dedicated concierge and other rewards.

We see a meaningful opportunity to grow our Madewell Insider program and promote existing Madewell Insiders to higher loyalty tiers. Our Madewell Insiders are our highest value customers. In fiscal 2018, nearly 80% of all $500+ spenders were loyalty members. While $500+ spenders represented approximately 9% of all customers, they drove over 45% of total revenue in fiscal 2018, highlighting the opportunity to promote existing Madewell Insiders to higher loyalty tiers. In fiscal 2019, we will be enhancing the Madewell Insider program by launching a points offering that allows customers to earn reward dollars. We believe that members will see points and rewards as an exciting supplement to the current perks, and that the offering will support our efforts to drive purchase frequency.

Increase our E-Commerce Led DTC Rollout

The integration of stores and e-commerce is fundamental to our customer-first strategy and helping to create more loyal, omnichannel customers. We intend to drive DTC revenue by growing our e-commerce penetration and selectively expanding our store network.

Grow E-Commerce Penetration

We believe there is a significant opportunity to expand our e-commerce penetration from 37% of DTC revenue in fiscal 2018 to over 50% of total DTC revenue and expand our Adjusted EBITDA margins as a result. We plan to achieve this by capitalizing on overall growth in the online specialty retail industry as well as by



 

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employing several critical initiatives to drive our e-commerce penetration. We intend to support net revenue growth at madewell.com through the following robust e-commerce strategies, which we believe will drive increased cross-channel migration, converting single-channel customers into more engaged, more valuable omnichannel customers:

 

   

Expand E-Commerce Assortment: We will continue expanding our e-commerce assortment by adding more size options, as well as expanding our selection of products in strategic categories such as swimwear, dresses and sneakers. We also plan to increase our denim assortment by extending our women’s denim assortment across a broader range of prices and by expanding our men’s offering.

 

   

Further Accelerate Digital Marketing: We will continue to invest in digital marketing to drive customer acquisition. We plan to broaden and deepen our spend across channels from social media to search engine optimization. We will continue to use data driven decision-making to ensure our marketing spend is being allocated in an efficient manner.

 

   

Grow Mobile and Launch App: We plan to launch a mobile app in 2020 that will be loyalty-centric and feature omnichannel capabilities, such as app payment in-store. This should create a more seamless experience across devices and reinforce our customer-focused digital model.

 

   

Increase Personalization and Dynamic Presentation: We are testing several personalization initiatives to drive deeper engagement and performance. Key initiatives include personalized assortments, styling recommendations and promotional offers, as well as geo-targeting to push local events and seasonal assortments. This will funnel the most relevant content to our customers, enabling increased conversion from single-channel to omnichannel purchase behavior.

Selectively Expand Store Network

Our store network is a key component of our omnichannel model, with over 60% of new-to-brand customers making their first purchase in stores in fiscal 2018. Our stores are extremely productive and profitable, generating an average of approximately $1,100 in sales per selling square foot, which we believe is among the highest of our peers. We plan to open 10 to 15 stores per year for the foreseeable future, targeting approximately 3,000 square foot sites in upscale lifestyle centers and street locations. We are also testing new store concepts focused on denim and concepts tailored to local markets that enhance our community engagement. In fiscal 2018, we organized over 2,500 store based events and we plan to continue to utilize our stores as hubs for community engagement in the future.

Expand Our Product Categories

We are actively focused on growing our product categories and believe there is substantial opportunity to expand our product categories in four key areas:

 

   

Denim: We plan to increase our market share in women’s denim in the $100-$150 price range and to expand further into the $75-$100 and $150+ price ranges. In fiscal 2017, we successfully introduced our popular $75 Roadtripper jean, which we believe is contributing to incremental customer reach. We believe we have a meaningful opportunity to expand denim revenue to over $500 million globally on an annual basis, by growing share in existing and adjacent markets.

 

   

Everything You Wear with Jeans: We continue to see additional opportunities to grow in categories such as leather goods and bags (amplified by our monogramming and personalization capabilities),



 

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tops and accessories. Footwear continues to be a destination category and in fiscal 2019 we successfully launched our first Madewell sneaker, the Sidewalk Sneaker. We believe we can have similar success in launching additional new products in destination categories.

 

   

Lifestyle: Expanding categories such as dresses, beauty, swimwear, jewelry and sunglasses provides a further avenue for growth. In fiscal 2019, we introduced our Second Wave sustainable swimwear collection made entirely of recycled materials.

 

   

Men’s: We launched our men’s line on our website in fiscal 2018 and plan to expand our assortment by focusing first on denim and then broadening the product range. We believe our premium denim at non-premium prices and our relaxed and timeless aesthetic will appeal to men as it has with women. In Fall 2019, we plan to launch a dual gender marketing campaign and test seven shop-in-shop men’s stores.

Grow Wholesale and International

We believe we have a strong opportunity to grow our wholesale business and to expand our business globally through both our e-commerce and wholesale channels. Since launching wholesale in 2015 with Nordstrom we have experienced rapid growth through this partner, becoming one of the leading young contemporary brands at Nordstrom. We have since expanded our selective wholesale partnerships to include Net-a-Porter, Zalando and Shopbop. We intend to add highly selective premium wholesale points of distribution and develop new global wholesale relationships to expand wholesale internationally. We also plan to grow internationally through our e-commerce platforms and we are exploring the opportunity to develop localized websites in several countries with market-specific content, language and currency.

The Reorganization

Prior to the completion of this offering, Chinos Holdings is a holding company that is the ultimate parent of various subsidiaries that operate the Madewell business and the J.Crew business.

Concurrent with the completion of this offering, Chinos Holdings will undergo a series of transactions pursuant to which it will:

 

   

effect the Separation, pursuant to which it will spinoff the J.Crew business to its stockholders, after which (i) the J.Crew business will cease to be a part of Chinos Holdings and (ii) certain pre-Separation indebtedness of Chinos Holdings will be an obligation of the J.Crew business and will not be an obligation of Chinos Holdings on a consolidated basis;

 

   

enter into the Transition Services Agreement and other related agreements, pursuant to which entities operating the J.Crew business will continue to provide us with certain administrative capabilities for a specified period of time following the Separation;

 

   

exchange shares of its common stock for certain of its pre-Separation indebtedness;

 

   

incur new debt obligations and use the net proceeds it receives therefrom together with the proceeds from this offering to repay its remaining pre-Separation indebtedness; and

 

   

convert its preferred stock into common stock.

We refer to these transactions, together with this offering, collectively as the “Reorganization.” See “The Reorganization” and “Other Information Related to this Offering—Certain Relationships and Related Party Transactions—Relationship with J.Crew.”



 

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After the Reorganization, Chinos Holdings will no longer directly or indirectly own or operate the J.Crew business and the only business of Chinos Holdings will be the Madewell business. Accordingly, the Madewell business is the business in which you are investing if you buy shares of common stock in this offering. In addition, Chinos Holdings will not be an obligor or guarantor of, or have any assets pledged as collateral for, any of its pre-Reorganization indebtedness after the Reorganization.

We will provide further information regarding the Reorganization in subsequent amendments to the registration statement, of which this prospectus is a part, and prior to the completion of this offering.

Risks Associated with Our Business

Investing in our common stock involves a number of risks. These risks represent challenges to the successful implementation of our strategy and the growth of our business. Some of these risks are:

 

   

Our failure to predict fashion trends or react to changing consumer preferences in a timely manner.

 

   

Damage to our brand or reputation due to negative publicity.

 

   

Heightened competition from other specialty retailers, including those with a similar focus on denim, certain of which have substantially greater resources than we do.

 

   

Our ability to expand and improve our omnichannel capabilities through the further integration of our in store and e-commerce channels.

 

   

Our ability to execute on our real estate strategy.

 

   

Disruptions to the operations of our order and distribution centers or failure of third-party vendors.

 

   

Changes in U.S. foreign trade policy, the imposition of tariffs or trade disputes.

 

   

The impact of global economic conditions affecting the production or transportation costs of our products.

 

   

Our dependence on our relationship with J.Crew for certain operational and corporate functions following the Separation and J.Crew’s ability to perform these functions.

 

   

Changes in, or failure to comply with, government regulation of the Internet and e-commerce, data privacy, anti-corruption and anti-bribery laws.

 

   

Our substantial indebtedness following the Reorganization.

 

   

The loss of our access to certain of J.Crew’s brand, services, reputation, capital base and other resources following the Reorganization.

For a discussion of these and other risks you should consider before making an investment in our common stock, see the section entitled “Risk Factors.”

Corporate Information

Chinos Holdings was incorporated in the State of Delaware on November 17, 2010. Prior to the completion of this offering Chinos Holdings will be renamed Madewell Group, Inc. Our headquarters is located at 30-30 47th Ave, Long Island City, New York 11101 and our telephone number is (718) 340-5701.



 

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THE OFFERING

 

Issuer

Chinos Holdings, Inc. (to be renamed Madewell Group, Inc. prior to the completion of this offering)

 

Common stock offered by us

                 shares of common stock (or                 shares of common stock if the underwriters exercise their option to purchase additional shares in full).

 

Common stock to be outstanding after this offering

                 shares of common stock (or                 shares of common stock if the underwriters exercise their option to purchase additional shares in full).

 

Option to purchase additional shares of common stock

The underwriters have an option to purchase an additional                  shares of common stock from us. The underwriters can exercise this option at any time within 30 days from the date of this prospectus.

 

Use of proceeds

We estimate that the net proceeds from the sale of our common stock in this offering, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, will be approximately $         million ($         million if the underwriters exercise their option to purchase additional shares in full) based on an assumed initial public offering price of $             per share (the midpoint of the estimated public offering price range set forth on the cover page of this prospectus).

 

  We intend to use these net proceeds, together with proceeds from debt obligations we will incur in connection with the Reorganization, to repay certain of Chinos Holdings’ pre-Reorganization indebtedness and the remainder for general corporate purposes. See “Use of Proceeds.”

 

The Reorganization

See “The Reorganization.”

 

Dividend policy

We do not currently intend to pay cash dividends on our common stock in the foreseeable future. However, in the future, subject to the factors described below and our future liquidity and capitalization, we may change this policy and choose to pay dividends. See “Dividend Policy.”

 

Risk Factors

Investing in our common stock involves a high degree of risk. See the “Risk Factors” section of this prospectus for a discussion of factors you should carefully consider before investing in our common stock.

 

Listing

We intend to apply to have our common stock listed on the NYSE or NASDAQ under the symbol “             .”


 

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Except as otherwise indicated, the number of shares of our common stock outstanding after this offering:

 

   

gives effect to the conversion of the preferred stock of Chinos Holdings into common stock on a              for             basis in connection with the Reorganization;

 

   

gives effect to the remainder of the Reorganization transactions;

 

   

gives effect to the stock split of Chinos Holdings common stock on a             for             basis;

 

   

assumes no exercise of the underwriters’ option to purchase additional shares;

 

   

assumes an initial public offering price of $            per share (the midpoint of the estimated public offering price range set forth on the cover page of this prospectus);

 

   

excludes an aggregate of                  shares of our common stock that will be available for future equity awards under our 2019 Equity Incentive Plan; and

 

   

gives effect to our amended and restated certificate of incorporation and our amended and restated bylaws, which will be in effect prior to the completion of this offering.



 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA OF CHINOS HOLDINGS

The following tables set forth the summary historical consolidated financial data of Chinos Holdings and its consolidated subsidiaries. They include the results of operations, assets and liabilities associated with both the Madewell business and J.Crew business. The J.Crew business will be spun off from Chinos Holdings in the Separation. An investment in us in this offering is an investment in the Madewell business. We will not own, operate or have any interest in the J.Crew business following the Reorganization, however, we will receive certain services from and make related payments to the J.Crew business under the Transition Services Agreement as further described in “Other Information Related to this Offering—Certain Relationships and Related Party Transactions—Relationship with J.Crew—Transition Services Agreement” contained elsewhere in this prospectus. You should read the information set forth below in conjunction with “Use of Proceeds,” “Capitalization,” “Additional Information Related to Chinos Holdings—Selected Historical Consolidated Financial Data of Chinos Holdings,” “Additional Information Related to Chinos Holdings—Management’s Discussion and Analysis of Financial Condition and Results of Operations of Chinos Holdings” and the audited historical consolidated financial statements of Chinos Holdings and the notes thereto included elsewhere in this prospectus.

The statement of operations data for each of fiscal 2018, fiscal 2017 and fiscal 2016 set forth below are based on the historical consolidated financial statements of Chinos Holdings included elsewhere in this prospectus. Once we have completed the Reorganization, results of operations of the J.Crew business will be reported as discontinued operations for accounting purposes and our continuing operations will consist solely of the Madewell business. See “—Supplemental Summary Historical Combined Financial Data of the Madewell Business” for additional information regarding the operations and assets and liabilities of the Madewell business. Accordingly, the historical results of Chinos Holdings presented below will not be indicative of the results to be expected for any future period.



 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

    

For the Year Ended

 
(Dollars in thousands)   

February 2,

2019

   

February 3,

2018(a)

   

January 28,

2017

 

Statements of Operations Data:

      

Revenues:

      

J.Crew

   $ 1,779,547     $ 1,848,034     $ 2,018,542  

Madewell

     529,148       419,776       341,468  

Other

     175,299       105,885       71,585  

Total revenues

     2,483,994       2,373,695       2,431,595  
  

 

 

   

 

 

   

 

 

 

Cost of goods sold, including buying and occupancy costs

     1,648,330       1,476,064       1,550,305  
  

 

 

   

 

 

   

 

 

 

Gross profit

     835,664       897,631       881,290  

Selling, general and administrative expenses

     814,337       851,658       824,290  

Loss before income taxes

     (68,176     (204,829     (76,717

Benefit for income taxes

     (398     (133,120     (6,308

Net loss

   $ (67,778   $ (71,709   $ (70,409
  

 

 

   

 

 

   

 

 

 

Statements of Cash Flows Data:

      

Net cash provided by (used in):

      

Operating activities

   $ 6,941     $ 80,581     $ 137,862  

Investing activities

   $ (52,736   $ (37,148   $ (80,140

Financing activities

   $ (21,250   $ (67,600   $ (12,852

Pro forma net loss per common share—basic and diluted

   $        

Dividends per common share—basic and diluted

   $ —         —         —    

Pro forma weighted average common shares outstanding—basic and diluted

   $        
    

For the Year Ended

   

 

 
(Dollars in thousands)   

February 2,

2019

   

February 3,

2018

   

 

 

Balance Sheet Data:

      

Total current assets

   $ 564,856     $ 500,205    

Property and equipment, net

     243,620       289,441    

Total assets

     1,223,937       1,212,622    

Total current liabilities

     680,217       495,458    

Total liabilities

     2,599,374       2,511,510    

Accumulated deficit

     (2,172,745     (2,104,967  

Total stockholders’ deficit

   $ (1,569,749   $ (1,481,445  

 

(a)

Consists of 53 weeks.



 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

SUMMARY UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL DATA OF CHINOS HOLDINGS

The following table sets forth the summary unaudited pro forma consolidated statements of income of Chinos Holdings for fiscal 2018. They give effect to anticipated transactions and adjustments that are relevant to an understanding of the business for purposes of this offering and will have a material impact on the comparability of the results of operations of Chinos Holdings. They are described below and are as follows: (i) “—The Separation” (ii) “—The Transition Services Agreement” and (iii) “—This Offering.” You should read the information set forth below together with “Additional Information Related to Chinos Holdings—Unaudited Pro Forma Consolidated Financial Data of Chinos Holdings” included elsewhere in this prospectus. For summary information related to the pro forma and pro forma, as adjusted balance sheet of Chinos Holdings after giving effect to this offering, please see “—Supplemental Summary Historical Combined Financial Data of the Madewell Business.” Finally, for additional information relating to the Reorganization and the use of our proceeds from this offering, please see “The Reorganization,” “Use of Proceeds” and “Capitalization.”

The Separation. Chinos Holdings will undergo a series of transactions to legally separate the Madewell business from the J.Crew business concurrent with the completion of this offering. We refer to this series of transactions as the “Separation.” After the Separation, certain pre-Separation indebtedness of Chinos Holdings will be an obligation of the J.Crew business and will not be an obligation of Chinos Holdings on a consolidated basis. Once these transactions have occurred, the J.Crew business will be owned and operated separately from us. After the Reorganization, the Madewell business will represent our only assets, liabilities and operations. Although Chinos Holdings is the legal issuer of the shares offered in this offering, an investment in us is an investment in the Madewell business.

The Transition Services Agreement. In connection with the Separation, concurrent with this offering, we expect to enter into the Transition Services Agreement and other related agreements, pursuant to which entities operating the J.Crew business will continue to provide us with certain administrative capabilities for a specified period of time following the Reorganization. See “Other Information Related to this Offering—Certain Relationships and Related Party Transactions—Relationship with J.Crew.”

This Offering. Pro forma adjustments in connection with this offering to reflect (i) our receipt of the estimated net proceeds from the sale of common stock by us in the offering at an assumed initial public offering price of $         per share (the midpoint of the range appearing on the cover page of this prospectus), after deducting the assumed underwriting discount and commissions and estimated fees and expenses payable by us; (ii) the incurrence of new indebtedness in connection with the Reorganization; (iii) the application of the net proceeds of this offering together with the proceeds from the incurrence of new indebtedness to repay certain pre-Reorganization indebtedness of Chinos Holdings, as described in “Use of Proceeds”; and (iv) the exchange of shares of Chinos Holdings common stock for certain of its pre-Reorganization indebtedness. After the Reorganization, we will not be an obligor or guarantor of, or have any assets pledged as collateral for, any of Chinos Holdings’ pre-Reorganization indebtedness.

Once we have completed the Reorganization, results of operations of the J.Crew business will be reported as discontinued operations for accounting purposes and our continuing operations will consist solely of the Madewell business. The historical results of operations of the J.Crew business reported as discontinued operations may not be comparable to the adjustments to our unaudited pro forma consolidated financial data for the Separation of the J.Crew business.



 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

SUMMARY UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS

YEAR ENDED FEBRUARY 2, 2019

 

          

The Separation

    

The Transition Services

Agreement

    

This Offering

 
    

Actual

   

Separation

Adjustments

    

Pro

Forma

    

Transition

Services

Agreement

Adjustments

    

Pro

Forma

    

Offering

Adjustments

    

Pro

Forma

 
(Dollars in thousands)                                                

Revenues

   $ 2,483,994     $                    $                    $                    $                    $                    $                

Cost of goods sold, including buying and occupancy costs

     1,648,330                   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

   $ 835,664     $        $        $        $        $        $    
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Selling, general and administrative expenses

     814,337                   

Loss before income taxes

     (68,176                 

Benefit for income taxes

     (398                 
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ (67,778   $        $        $        $        $        $    
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) per share

                   

Basic

   $ (0.86   $        $        $        $        $        $    

Diluted

   $ (0.86   $        $        $        $        $        $    

Weighted average common shares outstanding (in thousands)

                   

Basic

     113,057                   

Diluted

     113,057                   

We will provide notes to our summary unaudited pro forma consolidated financial statements in subsequent amendments to the registration statement, of which this prospectus is a part, and prior to the completion of this offering.



 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

SUPPLEMENTAL SUMMARY HISTORICAL COMBINED FINANCIAL DATA OF THE MADEWELL BUSINESS

The following tables set forth the supplemental summary historical combined financial data of the Madewell business.

Please note the following:

 

   

Chinos Holdings, Inc. (to be renamed Madewell Group, Inc. prior to the completion of this offering) is the legal issuer of the shares offered in this offering. Although investors in this offering will be purchasing shares of Chinos Holdings, they will be investing only in the Madewell business;

 

   

the information set forth below is provided as supplemental information and should not be considered to be in lieu of the information pertaining to Chinos Holdings; and

 

   

the financial information included herein and in the supplemental historical combined financial statements of the Madewell business may not be indicative of our results of operations, financial condition and changes in equity after the completion of the Reorganization, or what they would have been had we operated the Madewell business separately from the J.Crew business as a standalone, publicly traded company during the periods presented.

The supplemental summary historical combined statements of income data of the Madewell business for fiscal 2018, fiscal 2017 and fiscal 2016 and the supplemental summary historical combined balance sheet data of the Madewell business as of February 2, 2019 are based on the supplemental historical combined financial statements of the Madewell business and related notes thereto included elsewhere in this prospectus. The historical results of the Madewell business are not necessarily indicative of the results to be expected in any future period.

The supplemental historical combined financial statements of the Madewell business have been derived from Chinos Holdings’ consolidated financial statements and accounting records and represent the financial condition and results of operations of the Madewell business on a carveout basis, prepared in accordance with U.S. GAAP. The J.Crew business currently provides certain services to the Madewell business, and the supplemental historical combined financial statements of the Madewell business reflect an allocation of the Allocated Costs, which are certain Chinos Holdings corporate costs, including, among others, finance, information technology, human resources, corporate occupancy, legal, production and sourcing, supply chain, store and e-commerce operations and executive leadership. Allocated Costs are not necessarily indicative of the expenses that we will incur under the Transition Services Agreement, or that we would have incurred or we may incur in the future if we were operating the Madewell business as a standalone, publicly traded company. The amount and composition of our expenses may vary from historical levels since the fees charged for the services under the Transition Services Agreement may be higher or lower than the Allocated Costs. In addition, we intend to replace these services over time with ones supplied either internally by our employees or by third parties, the cost of which may be higher or lower than the Allocated Costs. The difference between the Allocated Costs and the costs we will incur under the Transition Services Agreement or that we will incur as we replace these services and after the expiration of the Transition Services Agreement may be material. See “Basis of Financial Presentation.”

The supplemental historical combined financial statements of the Madewell business do not include an allocation of debt or interest expense from Chinos Holdings because the Madewell business is not considered the obligor of such debt for accounting purposes and because the borrowings were not directly attributable to the Madewell business. We will incur new debt obligations in connection with the Reorganization and will incur



 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

interest expense in connection therewith, which will impact our financial condition and results of operations in the future. We will not be an obligor or a guarantor of any of Chinos Holdings’ pre-Reorganization indebtedness after the Reorganization.

The summary balance sheet data of Chinos Holdings dated as of February 2, 2019 set forth below is derived from the historical consolidated financial statements of Chinos Holdings included elsewhere in this prospectus. We have included the summary balance sheet data of Chinos Holdings on an actual, pro forma and pro forma, as adjusted basis, each as of February 3, 2019, to reflect the assets and liabilities of the business in which you will be investing. See “Additional Information Related to Chinos Holdings—Unaudited Pro Forma Consolidated Financial Data of Chinos Holdings.”

You should read the information set forth below in conjunction with “Basis of Financial Presentation,” “Use of Proceeds,” “Capitalization,” “Additional Information Related to Chinos Holdings—Unaudited Pro Forma Consolidated Financial Data of Chinos Holdings,” “Additional Information Related to the Madewell Business—Supplemental Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Madewell Business,” “Additional Information Related to the Madewell Business—Supplemental Selected Historical Combined Financial Data of the Madewell Business,” and the supplemental historical combined financial statements of the Madewell business and the related notes thereto included elsewhere in this prospectus.

Supplemental Summary Historical Combined Financial Data of the Madewell Business

 

    

For the Year Ended

 
(Dollars in thousands)   

February 2,

2019

   

February 3,

2018(a)

   

January 28,

2017

 

Statements of Income Data:

      

Revenues

   $ 613,666     $ 463,512     $ 364,456  

Cost of goods sold, including buying and occupancy costs(b)

     316,588       233,458       208,358  
  

 

 

   

 

 

   

 

 

 

Gross profit(b)

     297,078       230,054       156,098  

Selling, general and administrative expenses(b)

     215,361       167,015       136,783  
  

 

 

   

 

 

   

 

 

 

Income before income taxes

     81,717       63,039       19,315  

Provision for income taxes

     21,297       18,526       7,599  
  

 

 

   

 

 

   

 

 

 

Net income

   $ 60,420     $ 44,513     $ 11,716  
  

 

 

   

 

 

   

 

 

 

Statements of Cash Flows Data:

      

Net cash provided by (used in):

      

Operating activities

   $ 64,123     $ 68,430     $ 41,384  

Investing activities

     —         —         —    

Financing activities

   $ (63,023   $ (67,872   $ (41,179

Other Financial Data (non-U.S. GAAP):

      

Adjusted EBITDA(c)

   $ 110,885     $ 93,716     $ 48,444  

The following balance sheet data as of February 2, 2019 is presented:

 

   

on an actual basis for the Madewell business on a carveout basis;

 

   

on an actual basis for Chinos Holdings;

 

   

on a pro forma basis to reflect changes in Chinos Holdings’ balance sheet to give effect to (i) the Separation and (ii) the Transition Services Agreement, as if such transactions had occurred on



 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

 

February 2, 2019. See “Additional Information Related to Chinos Holdings—Unaudited Pro Forma Consolidated Financial Data of Chinos Holdings” for additional information; and

 

   

on a pro forma, as adjusted basis to further reflect changes in Chinos Holdings’ balance sheet to give effect to (i) our receipt of the estimated net proceeds from the sale of common stock by us in the offering at an assumed initial public offering price of $        per share (the midpoint of the range appearing on the cover page of this prospectus), after deducting the assumed underwriting discount and commissions and estimated fees and expenses payable by us; (ii) the incurrence of new indebtedness in connection with the Reorganization; (iii) the application of the net proceeds of this offering together with the net proceeds from the incurrence of new indebtedness to repay certain pre-Reorganization indebtedness of Chinos Holdings, as described in “Use of Proceeds;” and (iv) the exchange of shares of Chinos Holdings common stock for certain of its pre-Reorganization indebtedness, as if such transactions had occurred on February 2, 2019.

 

    

As of February 2, 2019

 
(Dollars in thousands)   

Actual

Madewell

Business

    

Actual Chinos

Holdings

   

Pro Forma

Chinos Holdings

    

Pro Forma, As

Adjusted Chinos

Holdings

 

Balance Sheet Data:

          

Total current assets

   $ 4,133      $ 564,856     $                        $                    
  

 

 

    

 

 

   

 

 

    

 

 

 

Property and equipment, net

     54,050        243,620       

Total assets

     354,254        1,223,937       
  

 

 

    

 

 

   

 

 

    

 

 

 

Due to Parent

     56,584        —         
  

 

 

    

 

 

   

 

 

    

 

 

 

Total current liabilities

     168,830        680,217       
  

 

 

    

 

 

   

 

 

    

 

 

 

Long-term debt, net

     —          1,766,919       
  

 

 

    

 

 

   

 

 

    

 

 

 

Total liabilities

     207,781        2,599,374       
  

 

 

    

 

 

   

 

 

    

 

 

 

Retained earnings (accumulated deficit)

     146,473        (2,172,745     
  

 

 

    

 

 

   

 

 

    

 

 

 

Total stockholders’ equity (deficit)

   $ 146,473      $ (1,569,749   $        $    
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(a)

Consists of 53 weeks.

(b)

We exclude a portion of our distribution network costs from cost of goods sold and include them in selling, general and administrative expenses. Our gross profit therefore may not be directly comparable to that of some of our competitors. See Note 2: Allocated Costs in the notes to the supplemental historical combined financial statements of the Madewell business for further detail.

(c)

We define Adjusted EBITDA as combined net income before depreciation and amortization, interest expense and provision for income taxes adjusted for the impact of certain items, including non-cash and other items we do not consider representative of our ongoing operating performance. Because Adjusted EBITDA omits these items, we feel that it is less susceptible to variances in actual performance resulting from depreciation, amortization and other non-cash charges. We believe Adjusted EBITDA is a useful measure of operating performance, as it provides a clearer picture of our results of operations by eliminating expenses that are not reflective of underlying business performance. We use Adjusted EBITDA to monitor the performance of our business and we believe the presentation of this measure will enhance the ability of our investors to analyze trends in our business and evaluate our performance relative to other companies in the industry. However, Adjusted EBITDA is a non-U.S. GAAP financial measure that has limitations as an analytical tool. Adjusted EBITDA should not be considered an alternative to, or substitute for, net income, which is calculated in accordance with U.S. GAAP. In addition, Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by unusual or nonrecurring items, or affected by similar nonrecurring items. Adjusted EBITDA has limitations as an analytical tool, and you should not



 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

  consider such measure either in isolation or as a substitute for analyzing our results as reported under U.S. GAAP. Our definition and calculation of Adjusted EBITDA is not necessarily comparable to other similarly titled measures used by other companies due to different methods of calculation. We recommend that you review the reconciliation of Adjusted EBITDA to net income, the most directly comparable U.S. GAAP financial measure, and not rely solely on Adjusted EBITDA or any single financial measure to evaluate our business. The following is a reconciliation of adjusted EBITDA to net income, as reported under U.S. GAAP for the years ended February 2, 2019, February 3, 2018 and January 28, 2017:

 

    

For the Year Ended

 
(Dollars in thousands)   

February 2,

2019

    

February 3,

2018

    

January 28,

2017

 

Net income

   $ 60,420      $   44,513      $ 11,716  

Provision for income taxes

     21,297        18,526        7,599  

Interest expense

     —          —          —    

Depreciation and amortization (including intangible assets)

     18,374        19,098        17,826  
  

 

 

    

 

 

    

 

 

 

EBITDA

   $ 100,091      $ 82,137      $   37,141  
  

 

 

    

 

 

    

 

 

 

Allocated depreciation

     8,112        8,394        7,280  

Charges related to workforce reductions

     2,046        1,284        145  

Transaction costs

     432        —          —    

Amortization of lease commitments

     187        1,474        3,722  

Share-based compensation

     17        427        156  
  

 

 

    

 

 

    

 

 

 

Adjusted EBITDA

   $ 110,885      $ 93,716      $ 48,444  
  

 

 

    

 

 

    

 

 

 


 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information in this prospectus before purchasing our common stock. If any of the following risks occur, our business, financial condition and results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and you may lose some or all of your investment. Although Chinos Holdings is the legal issuer of the shares offered in this offering, an investment in our common stock is an investment in the Madewell business and does not constitute an investment in the J.Crew business. Accordingly, these risk factors are focused on risks related to (i) the Madewell business and its industry, (ii) the Reorganization and (iii) this offering and ownership of the common stock of Chinos Holdings after this offering.

Risks Related to Our Business and Our Industry

If we are unable to predict fashion trends or react to changing consumer preferences in a timely manner, our sales will decrease, or we may need to sell excess inventory at marked-down prices, which would decrease our gross profits and net income and could have a material adverse effect on our business, financial condition and results of operations.

We believe our success depends in substantial part on our ability to:

 

   

originate and define product and fashion trends;

 

   

anticipate, predict and react to changing consumer demands in a timely manner; and

 

   

translate market trends into desirable, saleable products far in advance of their offerings in our stores and on our website.

Because we enter into commitments for the manufacture and purchase of merchandise well in advance of the season in which merchandise will be sold, we are vulnerable to changes in consumer demand, pricing shifts and suboptimal merchandise selection and timing of merchandise purchases. If we misjudge the market for our products, fail to successfully expand our product categories or misjudge the overall level of consumer demand, it could result in decreased demand for our merchandise and decreased sales and we may be faced with significant excess inventories for some products and missed opportunities for others. We may respond by increasing markdowns and promotional activity or re-selling excess products to our wholesale partners to reduce excess inventory, which would further decrease our gross profits and net income. At the end of fiscal 2018, we owned substantial excess merchandise inventories. As a result, we recorded a charge of $7.7 million for expected losses on the disposition of those inventories. Our brand’s image may also suffer if customers believe we no longer offer the latest fashions or if we fail to address and respond to customer feedback or complaints. The occurrence of these events, among others, could have a material adverse effect on our business, financial condition and results of operations.

Unfavorable economic conditions could materially adversely affect our business, financial condition and results of operations.

Economic conditions around the world can impact our customers and affect the general business environment in which we operate and compete. Our results can be impacted by a number of macroeconomic factors, including, but not limited to, consumer confidence and spending levels, employment rates, consumer credit availability, fuel and energy costs, raw materials costs, global factory production, commercial real estate market conditions, credit market conditions, foreign currency exchange rates, interest rates, taxation, acts of war or terrorism, the level of customer traffic in malls and shopping centers, changing demographic patterns and changes in consumer discretionary spending habits.

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

The specialty retail industry in which we operate is cyclical and demand for our merchandise is significantly impacted by negative trends in consumer confidence and other economic factors affecting consumer spending behavior, including the level of disposable consumer income, the availability of consumer credit, interest rates, foreign exchange rates, taxation and demographic patterns. Because apparel and accessories generally are discretionary purchases, consumer purchases of our products may decline during recessionary periods or when disposable income is lower. In addition, unfavorable economic conditions abroad may impact our ability to meet quality and production goals. As a result, unfavorable economic conditions at a regional, national or international level could have a material adverse effect on our business, financial condition and results of operations.

Periods of economic uncertainty or volatility make it difficult to plan, budget and forecast our business. Incorrect assumptions concerning economic trends, customer requirements, distribution models, demand forecasts, interest rate trends and availability of resources may result in our failure to accurately forecast results and to achieve forecasted results or budget targets.

Our success depends on our ability to grow Madewell brand awareness and enhance our connection to our customer base.

Our success depends in large part on our ability to effectively execute our marketing strategies to grow Madewell’s brand awareness among new customers and increase the value of existing customers. We have developed a community-based marketing strategy through which we engage with our customers across our digital platform, store footprint and events and turn our customers into brand advocates. We are also increasingly using digital and social media platforms to interact with customers and as a means to enhance their customer experience. We have made significant investments in digital marketing, which has resulted in an increase in new customers through our e-commerce channel. If we are unable to successfully drive community engagement and brand advocacy, including through our new retail concepts, develop and continuously improve our customer-facing technologies or effectively reach customers through our digital marketing efforts, we may not be able to provide a convenient and consistent experience to our customers regardless of the sales channel or we otherwise may experience slower customer growth or increased customer losses or increased digital marketing costs. This could negatively affect our ability to compete with other retailers and result in diminished loyalty to our brand.

If our marketing, promotion, merchandising or price mark-down strategies are not successful, if we fail to maintain high standards for merchandise quality and customer experience, if we fail to maintain high ethical, social and environmental and sustainability standards for all of our operations and activities or if we fail to appropriately respond to concerns associated with any of the foregoing or any other concerns from our customers, it could have a material adverse effect on our business, financial condition and results of operations. Damage to our reputation or loss of consumer confidence for these or any other reasons may reduce demand for our merchandise and require us to expend additional resources to rebuild our reputation.

Further, marketing and merchandising efforts designed to increase awareness of our brand require a substantial investment of capital, management time and other resources. If our efforts to grow our brand awareness are not successful, it could impact our ability to realize our e-commerce penetration goals and otherwise have a material adverse effect on our business, financial condition and results of operations.

We operate in the highly competitive specialty retail industry, and the size and resources of some of our competitors may allow them to compete more effectively than we can, which could result in loss of our market share.

We face intense competition in the specialty retail industry, including against competitors that also focus on denim and everything you wear with denim, and among other retailers more broadly. We compete with local, national and international retail chains and department stores, denim specialty stores and Internet businesses offering similar categories of merchandise. We compete primarily on the basis of our denim category

 

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expertise, in-house design and product development capabilities, brand image and recognition as well as innovation, style, distribution and price. We are not in the “fast fashion” business, but an increasing number of customers are attracted to the aggressive pricing strategies of those retailers. Many of our competitors are, and many of our potential competitors may be, larger and have greater financial, marketing and other resources, devote greater resources to the marketing and sale of their products, generate greater international brand recognition or adopt more aggressive pricing policies than we can. A number of our competitors are continuing to operate with a promotional business strategy, both in-store and online. To the extent a promotional environment requires us to change our markdown strategy, it could negatively impact our revenues and gross profit in the future.

Our e-commerce penetration depends on our ability to, among other things, enhance our omnichannel shopping experience, expand our e-commerce assortment, accelerate digital marketing and expand our mobile presence.

Our customers are seeking retail experiences which emphasize value, personalization and an omnichannel environment where the in-store and e-commerce shopping experiences are tightly integrated, and a key component of our growth strategy is increasing our e-commerce penetration to over 50% of total DTC revenue. We interact with many of our customers through our websites and we have a digital presence in approximately 100 countries. Customers increasingly utilize our e-commerce services to purchase our merchandise. If we are unable to continue to provide consumers a user-friendly, integrated experience and evolve our platform to satisfy consumer preferences or successfully implement our e-commerce penetration initiatives, such as expanding our online assortment, accelerating our digital marketing or launching our mobile app, the growth of our e-commerce business and our sales may be negatively impacted. If we do not implement and expand our omnichannel initiatives successfully or we do not realize our anticipated return on these investments, we could fail to meet our strategic and financial goals and it could have a material adverse effect on our business, financial condition and results of operations.

In addition, we have implemented systems to manage our inventory efficiently across all channels, to ship merchandise from stores to customers. However, these initiatives involve significant investments in information technology systems and significant operational changes, and the rapid pace of technological change may require us to incur costs to implement new systems and platforms to provide a desirable shopping experience for our customers, including our e-commerce platform. We may not be successful in developing or acquiring technology that is competitive and responsive to the needs of our customers or that provides a favorable return on our related investment, which could have a material adverse effect on our business, financial condition and results of operations.

Our inability to maintain or increase comparable company sales could cause our earnings to decline.

If our future comparable company sales fail to meet expectations, our earnings could decline. In the previous three fiscal years, our quarterly comparable company sales changes have ranged from 5% to 31% and can be expected to fluctuate in the future. A variety of factors affect comparable company sales, including fashion trends, competition, current economic conditions, pricing, inflation, the timing of the release of new merchandise and promotional events, changes in our merchandise mix, the success of marketing programs, timing and level of markdowns and weather conditions. A decrease in these metrics could have a material adverse effect on our business, financial condition and results of operations.

Additionally, the softening apparel demand in recent years has led to a more promotional environment across the specialty retail industry, which may impact our promotional posture and our gross margins in the future. This promotional pricing may have a negative effect on our brand’s image, which may be difficult to counteract even as the economy improves.

All of these factors may cause our comparable company sales to be materially lower than previous periods and our expectations, which could impact our ability to leverage fixed expenses, such as store rent and

 

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store asset depreciation, and could have a material adverse effect on our business, financial condition and results of operations as well as the price of our common stock.

We will depend on our relationship with J.Crew for certain operational and corporate functions following the Reorganization and if J.Crew is unable to perform these functions, it could have a material adverse effect on our business, financial condition and results of operations.

In connection with the Reorganization, concurrent with this offering, we expect to enter into the Transition Services Agreement and other related agreements, pursuant to which entities operating the J.Crew business will continue to provide us with certain administrative capabilities for a specified period of time following the Reorganization. J.Crew may become unable to fulfill its obligations under the Transition Services Agreement due to financial distress, insolvency, bankruptcy, receivership or similar proceedings or other reasons. If J.Crew becomes subject to a bankruptcy case, it may also seek to reject the Transition Services Agreement in accordance with the Bankruptcy Code. In any of the foregoing circumstances, we will be required to replace the services provided by J.Crew under the Transition Services Agreement, likely on an unplanned and expedited basis. We may not be able to replace these services or enter into appropriate third-party agreements in a timely manner, on terms and conditions, including cost, comparable to those that we will receive from J.Crew under our Transition Services Agreement, or at all. Any disruption to the operation of our business due to J.Crew’s inability to perform its obligations under the Transition Services Agreement could have a material adverse effect on our reputation, financial condition and results of operations.

In the event J.Crew becomes subject to a bankruptcy case, J.Crew’s creditors may request that a bankruptcy court substantively consolidate J.Crew and its debtor subsidiaries with Madewell, which would, among other things, allow the creditors of J.Crew to satisfy their claims from the combined assets of the consolidated Madewell and J.Crew entities.

If J.Crew becomes subject to a bankruptcy case, J.Crew’s creditors could request that the bankruptcy court substantively consolidate J.Crew’s assets and liabilities with our assets and liabilities even if we did not commence such bankruptcy case. Our substantive consolidation with J.Crew in a bankruptcy case would, among other things, allow the creditors of the bankrupt entities to satisfy their claims from the combined assets of the consolidated Madewell and J.Crew entities. In addition, substantive consolidation with J.Crew or its subsidiaries’ bankruptcies may subject our assets and operations to restrictions in the United States Bankruptcy Code of 1978, as amended, and may impair our ability to operate independently, as well as otherwise restrict our operations and capacity to function as a standalone enterprise. The substantive consolidation of our assets and liabilities with J.Crew’s in connection with any J.Crew bankruptcy case could have a material adverse effect on our business, financial condition and results of operations.

Our ability to source our merchandise profitably or at all could be hurt if new trade restrictions are imposed, existing trade restrictions become more burdensome or disruptions occur at our suppliers or at the ports.

Trade restrictions, including increased tariffs, safeguards or quotas, on apparel and accessories could increase the cost or reduce the supply of merchandise available to us. We source our merchandise through buying agents and, increasingly, by purchasing directly from manufacturers, predominately in Asia. As we expand our direct sourcing capabilities, we intend to reduce our reliance on buying agents, but our investments in direct sourcing may not be successful and may, in turn, have an adverse impact on our financial position and results of operations.

There are quotas and trade restrictions on certain categories of goods and apparel from China and countries that are not subject to the World Trade Organization Agreement, which could have a significant impact on our sourcing patterns in the future. In addition, political uncertainty in the United States may result in significant changes to U.S. trade policies, treaties and tariffs, potentially involving trade policies and tariffs

 

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regarding China, including the potential disallowance of tax deductions for imported merchandise or the imposition of unilateral tariffs on imported products. For example, general trade tensions between the United States and China have been escalating recently. The Trump Administration has recently imposed tariffs on goods imported from mainland China. In fiscal 2018, approximately 60% of our products were manufactured in mainland China. While such tariffs have not affected our business to date, if additional tariffs or trade restrictions are implemented by the United States or other countries in connection with a global trade war, the cost of our products manufactured in China or other countries and imported into the United States or other countries could increase, which in turn could adversely affect the demand for these products, or our margins on such products could decrease, negatively impacting our profitability. These developments, or the perception that any of them could occur, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global trade and, in particular, trade between these nations and the United States. Any of these factors could depress economic activity, restrict our sourcing from suppliers and have a material adverse effect on our business, financial condition and results of operations and affect our strategy in Asia and elsewhere around the world. We cannot predict whether any of the countries in which our merchandise or raw materials are currently manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the United States and foreign governments, nor can we predict the likelihood, type or effect of any such restrictions. Trade restrictions, including increased tariffs or quotas, embargoes, safeguards and customs restrictions against apparel items could increase the cost, delay shipping or reduce the supply of apparel available to us or may require us to modify our current business practices, any of which could have a material adverse effect on our business, financial condition and results of operations.

We rely on our suppliers to manufacture and ship the products they produce for us in a timely manner. We also rely on the free flow of goods through open and operational ports worldwide. Labor disputes at various ports or at our suppliers could increase costs for us and delay our receipt of merchandise, particularly if these disputes result in work slowdowns, lockouts, strikes or other disruptions.

The success of our business depends, in part, on our ability to execute on our real estate strategy, including maintaining profitable store locations and opening new store locations in a timely manner. Our inability to successfully implement our real estate strategy could have a material adverse effect on our business, financial condition and results of operations.

We expanded our store base by eight stores in fiscal 2018 and we plan to expand our store base by approximately 10 stores in fiscal 2019, of which three new store locations were open as of May 31, 2019, and by approximately 10 to 15 stores per year for the foreseeable future. We renegotiate with landlords to obtain more favorable lease terms as opportunities arise. The success of our business depends, in part, on our ability to identify, open and maintain profitable store locations and renew our existing store leases on terms that meet our financial targets. In addition, our store network is a key component of our strategy to expand our customer base, as over 60% of our new-to-brand customers made their first purchase in a store in fiscal 2018. Our ability to open new stores on schedule or at all, to renew our existing store leases on favorable terms or to operate them on a profitable basis depends on various factors, including our ability to:

 

   

identify suitable markets for new stores and available store locations;

 

   

anticipate the impact of changing economic and demographic conditions for new and existing store locations;

 

   

negotiate acceptable lease terms for new locations or renewal terms for existing locations;

 

   

hire and train qualified sales associates;

 

   

develop new merchandise and manage inventory effectively to meet the needs of new and existing stores on a timely basis;

 

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foster current relationships and develop new relationships with vendors that are capable of supplying the required volume of merchandise;

 

   

avoid construction delays and cost overruns in connection with the build-out of new stores; and

 

   

successfully increase our brand awareness and the size of our customer base.

New stores and stores with renewed lease terms may not produce anticipated levels of revenue even though they increase our costs, which would increase our expenses as a percentage of sales and could have a material adverse effect on our business, financial condition and results of operations.

We have grown rapidly in recent years and we have limited operating experience at our current scale of operations; if we are unable to manage our operations at our current size or to manage any future growth effectively, our brand image may suffer and it could have a material adverse effect on our business, financial condition and results of operations.

We have expanded our operations rapidly since we were introduced by J.Crew in 2006, and we have limited operating experience at our current size. If our operations continue to grow, of which there can be no assurance, we will be required to continue to expand our sales and marketing, product development and distribution functions, to upgrade our management information systems and other processes, and to obtain more space for our expanding administrative support and other headquarters personnel. Our continued growth could increase the strain on our resources, and we could experience serious operating difficulties, including difficulties in hiring, training and managing an increasing number of employees, difficulties in obtaining sufficient raw materials and manufacturing capacity to produce our products, and delays in production and shipments. In addition, immediately following the Reorganization, we will rely on J.Crew to provide certain operational and corporate functions to support our growth. We may have difficulty transitioning from services provided by J.Crew or be unable to replace such services at comparable costs. These difficulties could affect our operating performance and have a material adverse effect on our business, financial condition and results of operations.

Use of social media may materially and adversely affect our reputation or subject us to fines or other penalties.

The use of social media by us and our customers has increased the risk that our image and reputation could be negatively impacted. We rely to a large extent on our online presence to reach consumers, and we offer consumers the opportunity to rate and comment on our products on our website. Negative commentary regarding us or our products may be posted on our website or social media platforms and may be adverse to our reputation or business. Our target consumers often value readily available information and often act on such information without further investigation and without regard to its accuracy. The harm may be immediate without affording us an opportunity for redress or correction.

We also use third-party social media platforms as marketing tools. For example, we maintain Instagram, Facebook, Twitter, Pinterest and Youtube accounts. As e-commerce and social media platforms continue to rapidly evolve, we must continue to maintain a presence on these platforms and establish presences on new or emerging popular social media platforms. If we are unable to cost-effectively use social media platforms as marketing tools, our ability to acquire new consumers and our financial condition may suffer.

Further, as laws and regulations rapidly evolve to govern the use of these platforms and devices, the failure by us, our employees or third parties acting at our direction to abide by applicable laws and regulations in the use of these platforms and devices could subject us to regulatory investigations, class action lawsuits, liability, fines or other penalties and have a material adverse effect on our business, financial condition and result of operations.

 

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In addition, an increase in the use of social media for product promotion and marketing may cause an increase in the burden on us to monitor compliance of such materials, and increase the risk that such materials could contain problematic product or marketing claims in violation of applicable regulations.

Our expanded product offerings, new sales channels and new concepts may not be successful, and implementation or failure of these strategies may divert our operational, managerial, financial and administrative resources, which could impact our competitive position and have a material adverse effect on our business, financial condition and results of operations.

We have grown our business in recent years by expanding our product offerings and sales channels through, among others, retail, e-commerce and wholesale channels. In the future we may continue to make changes to our business, including by expanding our e-commerce assortment and introducing new products, expanding our prospecting capabilities, extending mobile and video reach, expanding payment options, diversifying our advertising strategy and growing our store base. These strategies involve various risks, including:

 

   

implementation may be delayed or may not be successful;

 

   

if our expanded product offerings, including our men’s apparel, and sales channels fail to maintain and enhance the distinctive identity of our brand, its image may be diminished and our sales may decrease;

 

   

if the implementation of our customer, e-commerce, and omnichannel initiatives is not successful, or we do not realize the return on our investments in these initiatives that we anticipate, we could experience a material adverse effect on our business, financial condition and results of operations;

 

   

if our marketing becomes less effective than that of our competitors, or if we do not adequately leverage technology and data analytics needed to generate concise competitive insight, we could experience a material adverse effect on our business, financial condition and results of operations; and

 

   

implementation of these plans may divert management’s attention from other aspects of our business, increase costs and place a strain on our management, operational and financial resources, as well as our information systems.

In addition, our revenues may be affected by, among other things, economic, demographic and competitive conditions, changes in consumer spending patterns and changes in consumer preferences and style trends. Further rollout of these strategies could be delayed or abandoned, could cost more than anticipated and could divert resources from other areas of our business or cause costly operational inefficiencies, any of which could impact our competitive position and reduce our revenue and profitability and have a material adverse effect on our business, financial condition and results of operations.

As we execute our growth strategies, we may not adequately manage the related organizational changes needed for successful execution, which could increase our costs or delay our intended pace of growth. In addition, we may divert key resources related to our core business as a result of the focus on growth strategies.

Interruption in our foreign sourcing operations could disrupt production, shipment or receipt of our merchandise, which would result in lost sales and increases in the demand for, or the price of, raw materials used to manufacture our products or other fluctuations in sourcing or distribution could increase our costs or negatively impact profitability.

We do not own or operate any manufacturing facilities and therefore depend upon independent third-party vendors for the manufacture of all of our products. Our products are manufactured to our specifications

 

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primarily by factories outside of the United States. We cannot control all of the various factors, which include inclement weather, natural disasters, political and financial instability, strikes, health concerns regarding infectious diseases and acts of war or terrorism that might affect a manufacturer’s ability to ship orders of our products in a timely manner or to meet our quality standards. Inadequate labor conditions, health or safety issues in the factories where goods are produced can negatively impact our brand reputation. Late delivery of products or delivery of products that do not meet our quality standards could cause us to miss the delivery date requirements of our customers or delay timely delivery of merchandise to our stores or our wholesale customers for those items. These events could cause us to fail to meet customer expectations, cause our retail or wholesale customers to cancel orders or cause us to be unable to deliver merchandise in sufficient quantities or of sufficient quality to our stores or our wholesale customers, which could result in lost sales and have a material adverse effect on our business, financial condition and results of operations.

The raw materials used to manufacture our products are also subject to availability constraints and price volatility caused by high demand for fabrics, weather, supply conditions, government regulations, economic climate and other unpredictable factors. In addition, our sourcing costs are subject to cost pressures, and the cost of labor at many of our third-party manufacturers and the cost of transportation have been increasing.

In fiscal 2018, we sourced our products from approximately 20 countries, with products sourced from mainland China representing 60% of our merchandise and products sourced from Vietnam and Indonesia representing an additional 20% of our merchandise during this time. Any event causing a sudden disruption of manufacturing or imports from Asia or elsewhere, including changes to U.S. and foreign trade policies, including the enactment of tariffs, border adjustment taxes or increases in duties or quotas applicable to our merchandise, could materially harm our operations. In addition, most of our products are shipped from our vendors by ocean. If a disruption occurs in the operation of the ports through which our products are imported, we may incur increased costs related to air freight, which is significantly more expensive than shipping by ocean, or to shipping to alternative ports, which could lead to delays in receipt of our products.

We have no long-term merchandise supply contracts and we typically transact business on an order-by-order basis. Many of our imports are subject to existing or potential duties, tariffs or quotas that may limit the quantity of certain types of goods that may be imported into the United States from countries in Asia or elsewhere. We compete with other companies for production facilities and import quota capacity. While substantially all foreign purchases of our products are negotiated and paid for in U.S. dollars, the cost of our products may be affected by fluctuations in the value of relevant foreign currencies. Our business is also subject to a variety of other risks generally associated with doing business abroad, such as political instability, economic conditions, disruption of imports by labor disputes and local business practices.

In addition to manufacturing in China, we are also engaging in growing the amount of production in other developing countries such as Vietnam and India. These other countries may present greater risks than China with regards to infrastructure to support manufacturing, labor and employee relations, political and economic stability, corruption and environmental, health and safety compliance. While we endeavor to monitor and audit facilities where our production is done, any significant events with factories we use can adversely impact our reputation, brand and product delivery and could have a material adverse effect on our business, financial condition and results of operations.

We may be unable to expand, or realize the benefits of, our wholesale business, which is currently reliant on one key customer.

In fiscal 2018, 12.8% of our revenue was from wholesale customers. We currently have wholesale partnerships with Net-a-porter, Nordstrom, Zalando and Shopbop. The effectiveness of our collaboration efforts with our wholesaler partners depends on our ability to maintain control over the presentation of our brand and the relationship with our customers. We continually evaluate opportunities to expand our wholesale business partnerships, including developing new global wholesale relationships to expand wholesale internationally, but

 

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there can be no assurance that we will be able to effectively identify or successfully execute on such opportunities. If we are unable to expand, or realize the benefits of, our wholesale business, it could have a material adverse effect on our business, financial condition and results of operations.

We depend on one customer for a large portion of our wholesale revenue. During fiscal 2018, sales to one customer accounted for 91% of wholesale revenue. The loss of this customer could have a significant impact on our revenues and could have a material adverse effect on our business, financial condition and results of operations.

Any material disruption of our information systems, or failure to maintain and develop our information systems, could have a material adverse effect on our business, financial condition and results of operations.

We rely extensively on information systems to operate our websites, process transactions, respond to customer inquiries, manage inventory, purchase, sell and ship goods on a timely basis and maintain cost-efficient operations. Prior to the Reorganization, we have relied on the information systems of J.Crew. We will continue to rely on these information systems pursuant to the Transitional Services Agreement for a specified period of time following the Reorganization, after which we will operate our information systems independently.

In the past, we have experienced system interruptions which temporarily impaired our ability to capture, process and ship customer orders, and transfer product between channels. We may experience operational problems with our information systems as a result of system failures, viruses, computer “hackers” or other causes. Any material disruption or slowdown of our systems, including a disruption or slowdown caused by a failure to successfully upgrade our systems, could cause information, including data related to customer orders, to be lost or delayed which could, especially if the disruption or slowdown occurred during the holiday season, result in delays in the delivery of merchandise to our stores and customers or lost sales, which could reduce demand for our merchandise and cause our sales to decline. If our website contains errors or other vulnerabilities which impede or halt service, it could result in damage to our brand’s image and a loss of revenue. In addition, if changes in technology cause the information systems we utilize to become obsolete, or if such information systems are inadequate to handle our growth, or if we experience difficulties related to transitioning from systems we share with J.Crew to systems we use as a standalone company, we could lose customers.

We are also subject to risks and uncertainties associated with the Internet, including changes in required technology interfaces, website downtime and other technical failures. Our failure to successfully respond to these risks and uncertainties could reduce sales, increase costs, damage the reputation of our brand and have a material adverse effect on our business, financial condition and results of operations.

Management uses information systems to support decision making and to monitor business performance. We may fail to generate accurate and complete financial and operational reports essential for making decisions at various levels of management, which could lead to decisions being made that have adverse results. Failure to adopt systematic procedures to initiate change requests, test changes, document changes and authorize changes to systems and processes prior to deployment may result in unsuccessful changes and could disrupt our business and reduce sales. In addition, if we do not maintain adequate controls such as reconciliations, segregation of duties and verification to prevent errors or incomplete information, our ability to successfully operate our business could be limited.

Compromises of our data security could cause us to incur unexpected expenses and loss of revenues and may materially harm our reputation and business.

Prior to the Reorganization, we have relied on J.Crew’s data security systems. We will continue to rely on J.Crew for data security pursuant to the Transitional Services Agreement for a specified period of time following the Reorganization, after which we will rely our own data security systems.

 

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In the ordinary course of our business, we collect and store certain personal information from individuals, such as our customers and employees, and we process customer payment card and check information. J.Crew relies on, and following the term of the Transition Services Agreement we expect to continue to rely on, commercially available systems, software, tools and monitoring to provide security for processing, transmission and storage of confidential information. As with many other companies in the specialty retail industry, we are subject to attempts to compromise our data security. There can be no assurance that we will not suffer a data compromise, that unauthorized parties will not gain access to personal information, or that any such data compromise or access will be discovered in a timely manner. Further, the systems currently used for transmission and approval of payment card transactions and the technology utilized in payment cards themselves, all of which can put payment card data at risk, are determined and controlled by the payment card industry, not by us. Computer hackers have attempted and we expect will continue to attempt to penetrate our computer system or those of third parties with whom we work or to whom we outsource business and, if successful, misappropriate personal information, payment card or check information or confidential business information of our company. In addition, there may be non-technical issues, such as our employees, contractors or third parties with whom we do business or to whom we outsource business operations may attempt to circumvent our security measures in order to misappropriate such information, and may purposefully or inadvertently cause a breach involving such information. Advances in computer and software technology and capabilities, rapid changes in the sources, methods and targets of cyberattacks (for example, malware, ransomware and phishing attacks) and the use of devices to tamper with payment entry devices (such as skimmers and shimmers) and the increasing sophistication of cyber criminals generally increase the risk of a data compromise or business disruption. In addition, transitioning from data security systems we share with J.Crew to data security systems we use as a standalone company could put us at additional risk. The specialty retail industry in particular has been the target of recent cyber-attacks, which are becoming increasingly difficult to anticipate and prevent due to their rapidly evolving nature. Both data privacy and information security are regulated at the international, federal and state levels and compliance with any changes in the laws and regulations enacted by these governments will likely increase the cost of doing business.

Compromises of our data security or that of third parties with whom we do business, failures to prevent or mitigate the loss of personal or business information and delays in detecting or providing prompt notice of any such compromise or loss could disrupt our operations, damage our reputation, decrease customers’ willingness to shop in our stores or on our websites, violate applicable laws, regulations, orders and agreements, or subject us to litigation, governmental investigations or additional costs and liabilities, any of which could have a material adverse effect on our business, financial condition and results of operations.

Failure to comply with privacy-related obligations, including privacy laws and regulations in the U.S. and internationally as well as other legal obligations, could have a material adverse effect on our business, financial condition and results of operations.

A variety of laws and regulations, in the United States and internationally, govern the collection, use, retention, sharing, transfer and security of personally identifiable information and data, including the European Union’s General Data Protection Regulation (“GDPR”), which became effective during fiscal 2018. We strive to comply with all applicable laws, regulations, self-regulatory requirements, policies and legal obligations relating to privacy, data usage and data protection. It is possible, however, that these laws, rules and regulations, which evolve frequently and may be inconsistent from one jurisdiction to another, could be interpreted to conflict with our practices. Any failure or perceived failure by us or any third parties with which we do business to comply with these laws, rules and regulations, or with other obligations to which we may be or become subject, may result in actions against us by governmental entities, private claims and litigation, fines, penalties or other liabilities. Any such action would be expensive to defend, could damage our reputation and could have a material adverse effect on our business, financial condition and results of operations.

 

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Our failure or inability to protect our intellectual property rights could diminish the value of our brand and weaken our competitive position.

Our Madewell trademark and variations thereon, such as Madewell.com, #everydaymadewell, Madewell Insider and Texture & Thread, are valuable assets that are critical to our success. We currently rely on a combination of copyright, trademark, trade dress, trade secret and unfair competition laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our intellectual property rights. Our efforts to establish and protect our intellectual property rights may not be adequate to prevent infringement of these rights by others, including imitation of our products and misappropriation of our trademarks. If we fail to protect and maintain our intellectual property rights, the value of our brand could be diminished and our competitive position may suffer, which could have a material adverse effect on our business, financial condition and results of operations.

We are subject to risks associated with leasing retail space subject to long-term and non-cancelable leases.

We lease our stores under operating leases and our inability to secure appropriate real estate or lease terms could impact our ability to grow. Our leases generally have an initial term of ten years, and generally can be extended in five-year increments if at all. We generally cannot cancel these leases at our option. If an existing or new store is not profitable, and we decide to close it, as we have done in the past and may do in the future, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. Similarly, we may be committed to perform our obligations under the applicable leases even if current locations of our stores become unattractive as demographic patterns change. In addition, as each of our leases expire, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could require us to close stores in desirable locations and have a material adverse effect on our business, financial condition and results of operations.

Our current and future operations substantially depend on our President and Chief Executive Officer and other current and future key executives and board members.

Our success depends, in substantial part, on our ability to attract and retain key personnel. In particular, the loss of the services of Libby Wadle, the Company’s President and Chief Executive Officer, would significantly impede implementation and execution of our business strategy and may result in the failure to reach our goals. The failure to enable a successful transition upon the departure of such key executives could hinder or delay our strategic planning and execution, as well as adversely affect our ability to attract and retain other experienced and talented employees.

Additionally, in connection with the Reorganization, we plan to hire additional key executives and members of our board of directors. Our future success will depend, in part, on the ability of our new executives and board members to quickly expand their knowledge of our operations, which will be critical to their ability to make informed decisions about our business and strategies, particularly given the competitive environment in which we operate. Many of the other specialty retail companies against which we compete for experienced talent have greater financial and other resources, different risk profiles, longer histories in the industry and greater ability to provide valuable cash or stock incentives to potential recruits than we do. They also may provide more diverse opportunities and better chances for career advancement. Competition for this experienced talent is intense and our failure to attract, train, retain and motivate such additional executives and board members could hinder or delay our strategic planning and execution, as well as adversely affect our ability to attract and retain other experienced and talented employees. The transition of our Board and management team may, during the period of transition, compromise our ability to compete effectively.

In addition, our management team lacks public company experience, which could impair our ability to comply with legal and regulatory requirements such as those imposed by the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”). Our management team has never had responsibility for managing a publicly traded

 

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company. Such responsibilities include complying with federal securities laws and making required disclosures on a timely basis. Our management team may not be able to implement programs and policies in an effective and timely manner that adequately responds to such increased legal, regulatory compliance and reporting requirements. Our failure to comply with all applicable requirements could lead to the imposition of fines and penalties and distract our management from attending to the growth of our business.

If members of our management or key individuals decide to leave us in the future, if we decide to make further changes to the composition of, or the roles and responsibilities of, these individuals, if we are not successful in attracting, motivating and retaining other key executives, board members and/or employees, if we are not able to effectively transition new management to our team or if our management team does not quickly adapt to managing a public company, it could have a material adverse effect on our business, financial condition and results of operations.

Any significant interruption in the operations of the customer call, order fulfillment and distribution centers we utilize could disrupt our ability to process customer orders and to deliver our merchandise in a timely manner, which could have a material adverse effect on our business, financial condition and results of operations.

Prior to the Reorganization, we utilized a 458,000 square foot facility in Lynchburg, Virginia owned by J.Crew that houses a customer call center and order fulfillment operations for our e-commerce business and a 284,000 square foot facility in Asheville, North Carolina owned by J.Crew that primarily supports our stores to replenish merchandise. We will continue to utilize these facilities pursuant to the Transition Services Agreement for a specified period of time following the Reorganization, after which we will move our fulfillment operations to a third-party provider.

Although J.Crew maintains back-up systems for these facilities and we have capabilities to bypass our distribution centers by fulfilling some e-commerce orders directly from our store locations, we may not be able to prevent a significant interruption in our operations if one or both of these facilities were impacted by a natural disaster, accident, failure of the inventory locator or automated packing and shipping systems we use or other events. We have experienced interruptions in the past in connection with website systems we share with J.Crew and there can be no assurance that future interruptions will not occur. In addition, we may experience difficulty transitioning from order fulfillment operations provided by J.Crew to those provided by a third-party, and comparable services provided by a third party may not be as effective as those currently provided by J.Crew, potentially resulting in additional interruptions, delays and costs. Any significant interruption in the operation of our order fulfillment operations, including an interruption caused by a failure to successfully expand or upgrade systems or manage transitions to utilizing the expansions or upgrades, could reduce our ability to receive and process orders and provide products and services to our stores and our wholesale and retail customers, which could result in lost sales, cancelled sales and a loss of loyalty to our brand and have a material adverse effect on our business, financial condition and results of operations.

Third-party failure to deliver merchandise to our distribution centers, stores and retail or wholesale customers or a disruption or adverse condition affecting our distribution centers could result in lost sales or reduced demand for our merchandise.

Our success depends on the timely receipt of merchandise from our vendors to our distribution centers and stores, and timely delivery of merchandise from our distribution centers to stores and retail or wholesale customers, as applicable. Independent third-party transportation companies deliver our merchandise to our distribution centers, stores and customers. Some of these third parties employ personnel represented by labor unions. Disruptions in the delivery of merchandise or work stoppages by employees of these third parties could delay the timely receipt of merchandise, which could result in cancelled sales, a loss of loyalty to our brand, increased logistics costs and excess inventory.

 

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Immediately following the Reorganization, we will utilize distribution centers operated by J.Crew in North Carolina and Virginia pursuant to the Transition Services Agreement. Timely receipt of merchandise by these distribution centers, stores and customers may be affected by factors such as inclement weather, natural disasters, accidents, system failures and acts of terrorism. We may respond by increasing markdowns or initiating marketing promotions, which would decrease our gross profits and net income. While we have had no labor-related work stoppages and we believe our relationship with our associates is good, work stoppages or efforts by our associates to unionize at either of our distribution centers could disrupt our operations and harm our reputation.

Inability to recover from a business interruption and return to normal operations within a reasonable period of time could have a material adverse impact on our business, financial condition and results of operations.

If our independent manufacturers do not use ethical business practices or comply with applicable laws and regulations, our brand could be harmed due to negative publicity, which could have a material adverse effect on our business, financial condition and results of operations.

While we partner with organizations such as Fair Trade USA to ensure high-quality working conditions at the manufacturing facilities that we use and we, along with third parties that we retain for this purpose, monitor compliance with fair trade practices, we do not control our independent manufacturers. Accordingly, we cannot guarantee their compliance with our guidelines or applicable laws and regulations. Violation of labor or other laws by our independent manufacturers, or the divergence of an independent manufacturer’s practices from those generally accepted as ethical in the United States could result in negative publicity which could diminish the value of the Madewell brand, reduce demand for our merchandise and have a material adverse effect on our business, financial condition and results of operations.

We are subject to customs, advertising, consumer protection, product safety, environmental, zoning and occupancy and labor and employment laws that could require us to modify our current business practices, incur increased costs or harm our reputation if we do not comply.

We are subject to numerous laws and regulations, including customs, truth-in-advertising, consumer protection, health information privacy, identity theft, online privacy, product safety, environmental, unsolicited commercial communication and zoning and occupancy laws and ordinances that regulate retailers generally and/or govern the importation, promotion and sale of merchandise and the operation of retail stores and warehouse facilities. Changes in federal and state minimum wage laws and other laws relating to employee benefits could cause us to incur additional wage and benefits costs, which could hurt our profitability.

Legal requirements frequently change and are subject to interpretation, and we are unable to predict the ultimate cost of compliance with these requirements or their effect on our operations. Failure to define clear roles and responsibilities or to regularly communicate with and train our associates may result in noncompliance with applicable laws and regulations. We may be required to make significant expenditures or modify our business practices to comply with existing or future laws and regulations, which may increase our costs and materially limit our ability to operate our business. We expect the costs of compliance and risks to our business in this area to increase as we expand our e-commerce business and execute on our strategy to expand internationally. If these regulations were to change or were violated by our management, associates, suppliers or buying agents, the costs of certain goods could increase, or we could experience delays in shipments of our goods, be subject to fines or penalties, or suffer reputational harm, which could reduce demand for our merchandise and have a material adverse effect on our business, financial condition and results of operations.

Our results of operations could be adversely impacted by currency exchange rate fluctuations.

Our international revenues are a small percentage of our business that may increase if we expand internationally. As a result, our future revenues may be impacted by changes in foreign currency exchange rates,

 

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which could have a material adverse effect on our business, financial condition and results of operations. Revenues and certain expenses in markets outside the United States are recognized in local foreign currencies, and we are exposed to potential gains or losses from the translation of those amounts into U.S. dollars for consolidation into our financial statements. Finally, our vendors and suppliers may also be impacted by currency exchange rate fluctuations with respect to the purchase of fabric and other raw materials.

Our business is affected by seasonality, which can result in fluctuations in our results of operations.

We experience moderate fluctuations in aggregate sales volume during the year. Historically, our revenues are generally lower during the first and second fiscal quarters and higher in the fourth fiscal quarter associated with the holiday shopping season. In fiscal 2018, our revenues in the first, second, third and fourth quarters represented 21%, 23%, 27% and 29%, respectively, of our total revenue for the year. Accordingly, any factors that harm our fourth fiscal quarter results of operations, including adverse weather or unfavorable economic conditions, could have a disproportionate material adverse effect on our business, financial condition and results of operations for the entire fiscal year.

In order to prepare for our peak shopping season, we must order and keep in stock significantly more merchandise than we would carry at other times of the year. Any unanticipated decrease in demand for our products during our peak shopping season could require us to sell excess inventory at a substantial markdown, which could reduce our net sales and gross profit. Additional unplanned decreases in demand for our products could produce further reductions to our net sales and gross profit.

Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including changes in discretionary spending, the timing of store openings and the revenues generated by new stores, merchandise mix and investments in marketing. As a result, historical period-to-period comparisons of our revenues and results of operations are not necessarily indicative of future period-to-period results. See “Additional Information Related to the Madewell Business—Supplemental Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Madewell Business.”

We have substantial goodwill recorded on our balance sheet, which may be subject to impairment losses in the future.

Certain factors, including consumer spending levels, industry and macroeconomic conditions, and the future profitability of our businesses, might have a negative impact on the carrying value of our goodwill and fixed assets. We could experience material impairment losses in the future. Although an impairment charge would be a non-cash expense, any impairment charges could materially increase our expenses and reduce our profitability. The process of testing goodwill for impairment involves numerous judgments, assumptions and estimates made by management including expected future profitability, cash flows and the fair values of assets and liabilities, which inherently reflect a high degree of uncertainty and may be affected by significant variability. If the business climate deteriorates, then actual results may not be consistent with these judgments, assumptions and estimates, and our goodwill may become impaired in future periods. This would, in turn, have a material adverse effect on our business, financial condition and results of operations.

We may be a party to legal proceedings in the future that could adversely affect our business.

From time to time, like others in the specialty retail industry, we are a party to legal proceedings, including matters involving personnel and employment issues, personal injury, intellectual property, consumer protection, consumer accessibility and other proceedings arising in the ordinary course of business. In addition, there are an increasing number of cases being filed in the specialty retail industry, including those that we have been subject to or may be subject to in the future, that contain class and representative action allegations, such as those relating to data privacy and wage and hour laws. We evaluate our exposure to these legal proceedings and establish reserves for the estimated liabilities in accordance with generally accepted accounting principles.

 

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Assessing and predicting the outcome of these matters involves substantial uncertainties. Although not currently anticipated by management, unexpected outcomes in these legal proceedings, or changes in management’s evaluations or predictions and accompanying changes in established reserves, could have a material adverse effect on our business, financial condition and results of operations.

We could be subject to changes in our tax rates and the adoption of new U.S. or international tax legislation or exposed to additional tax liabilities, which could have a material adverse effect on our business, financial condition and results of operations.

We are subject to taxes in the United States and in certain foreign jurisdictions. Due to economic and political conditions, tax rates in various jurisdictions may be subject to significant change. Our future effective tax rates could be affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, or changes in tax laws or their interpretation, including in the United States.

We are also subject to the examination of our tax returns and other tax matters by the Internal Revenue Service (the “IRS”) and other tax authorities and governmental bodies. We regularly assess the likelihood of an adverse outcome resulting from these examinations to determine the adequacy of our provision for taxes. There can be no assurance as to the outcome of these examinations. If our effective tax rates were to increase, particularly in the United States, or if the ultimate determination of our taxes owed is for an amount in excess of amounts previously accrued, it may have a material adverse effect on our business, financial condition and results of operations.

In December 2017, President Donald Trump signed into law legislation that significantly revises the Internal Revenue Code of 1986, as amended (the “Code”). Such changes include a reduction in the corporate tax rate from 35% to 21% and limitations on certain corporate deductions and credits, including significant limitations on the deductibility of interest, among other changes. Notwithstanding the reduction in the corporate income tax rate, the overall impact of this federal tax law has had and is expected to continue to have a negative impact on our results of operations, which may be material.

Reductions in the volume of mall traffic or the closing of shopping malls as a result of changing economic conditions or demographic patterns could significantly reduce our sales and leave us with excess inventory.

Approximately half of our stores are currently located in shopping malls. Sales at stores located in malls are highly dependent on the traffic in those malls and the ability of developers to generate traffic near our stores. Our stores benefit from the ability of the malls’ “anchor” tenants, generally large department stores and other area attractions, to generate consumer traffic in the vicinity of our stores. Unfavorable economic conditions and changes in consumer behavior, particularly in certain regions, have adversely affected mall traffic and resulted in the closing of certain anchor stores and has threatened the viability of certain commercial real estate firms which operate major shopping malls. A continuation of this trend, including failure of a large commercial landlord or continued declines in the popularity of mall shopping generally among our customers, would reduce our sales and leave us with excess inventory.

Inventory shrinkage could have a material adverse effect on our business, financial condition and results of operations.

We are subject to the risk of inventory loss and theft. Although our inventory shrinkage rates have not been material, or fluctuated significantly in recent years, there can be no assurances that actual rates of inventory loss and theft in the future will be within our estimates or that the measures we are taking will effectively reduce inventory shrinkage. Although some level of inventory shrinkage is an unavoidable cost of doing business, if we were to experience higher rates of inventory shrinkage or incur increased security costs to combat inventory theft, it could have a material adverse effect on our business, financial condition and results of operations.

 

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Parties with whom we do business may be subject to insolvency risks or may otherwise become unable or unwilling to perform their obligations with us.

We are party to contracts, transactions and business relationships with various third parties pursuant to which such third parties have performance, payment and other obligations to us. If any of these third parties were to become subject to bankruptcy, receivership or similar proceedings, our rights and benefits in relation to our contracts, transactions and business relationships with such third parties could be terminated, modified in a manner adverse to us, or otherwise impaired. We cannot make any assurances that we would be able to arrange for alternate or replacement contracts transactions or business relationships on terms as favorable as our existing contracts, transactions or business relationships, if at all. Any inability on our part to do so could have a material adverse effect on our business and results of operations.

The Reorganization and related transactions may expose us to potential liabilities arising out of state and federal fraudulent transfer laws and legal distribution requirements.

The Reorganization could be challenged under various state and federal fraudulent transfer laws. An unpaid creditor of J.Crew or a representative thereof could claim that the Reorganization is subject to avoidance pursuant to state or federal fraudulent transfer laws, including on the basis that (i) the Reorganization was effected to hinder, delay, or defraud the unpaid creditor, (ii) J.Crew received less than reasonably equivalent value in connection with the Reorganization and the Reorganization (a) was effected with, or resulted in, an insolvent J.Crew, (b) resulted in J.Crew having unreasonably small capital, or (c) resulted in J.Crew incurring debts beyond its ability to repay such debts as they mature. If a court believed that the Reorganization was not subject to a safe harbor and agreed with such unpaid creditor that the Reorganization constituted a fraudulent transfer, then such court could impose a number of different remedies, including voiding the Reorganization, returning our assets or your shares in our company to J.Crew or providing J.Crew with a claim for money damages against us in an amount equal to the difference between the consideration received by J.Crew and our fair market value at the time of the Reorganization. No assurance can be given as to what standard a court would apply to determine insolvency or that a court would determine that J.Crew was solvent at the time of or after giving effect to the Reorganization, including the distribution of our common stock. Any successful claim that the Reorganization was a fraudulent transfer would have a material adverse effect on our business, financial condition and results of operations.

Our business relies heavily on email and other messaging services, and any restrictions on the sending of emails or messages or any inability to timely deliver such communications could materially adversely affect our net revenue and business.

Our business is highly dependent upon email and other messaging services for promoting our brand, products and e-commerce platforms. We provide emails and “push” communications to inform consumers of new products, shipping specials and other promotions. We believe these messages are an important part of our consumer experience. If we are unable to successfully deliver emails or other messages to our subscribers, or if subscribers decline to open or read our messages, our net revenue and profitability would be materially adversely affected. Changes in how web and mail services block, organize and prioritize email may reduce the number of subscribers who receive or open our emails. For example, Google’s Gmail service has a feature that organizes incoming emails into categories (for example, primary, social and promotions). Such categorization or similar inbox organizational features may result in our emails being delivered in a less prominent location in a subscriber’s inbox or viewed as “spam” by our subscribers and may reduce the likelihood of that subscriber reading our emails. Actions by third parties to block, impose restrictions on or charge for the delivery of emails or other messages could also adversely impact our business. From time to time, Internet service providers or other third parties may block bulk email transmissions or otherwise experience technical difficulties that result in our inability to successfully deliver emails or other messages to consumers. Changes in the laws or regulations that limit our ability to send such communications or impose additional requirements upon us in connection with sending such communications would also materially adversely impact our business. Our use of email and other

 

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messaging services to send communications to consumers may also result in legal claims against us, which may cause us increased expenses, and if successful might result in fines and orders with costly reporting and compliance obligations or might limit or prohibit our ability to send emails or other messages. We also rely on social networking messaging services to send communications and to encourage consumers to send communications. Changes to the terms of these social networking services to limit promotional communications, any restrictions that would limit our ability or our consumers’ ability to send communications through their services, disruptions or downtime experienced by these social networking services or decline in the use of or engagement with social networking services by consumers could have a material adverse effect on our business, financial condition and results of operations.

Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or failure by us to comply with these regulations could substantially harm our business, financial condition and results of operations.

We are subject to general business regulations and laws as well as regulations and laws specifically governing the Internet and e-commerce. Existing and future regulations and laws could impede the growth of the Internet, e-commerce or mobile commerce. In addition to privacy and data security, these regulations and laws may involve taxes, tariffs, anti-spam, content protection, electronic contracts and communications, consumer protection, social media marketing, third-party cookies, web beacons and similar technology for online behavioral advertising and gift cards. It is not clear how existing laws governing issues such as property ownership, sales and other taxes and consumer privacy apply to the Internet as the vast majority of these laws were adopted prior to the advent of the Internet and do not contemplate or address the unique issues raised by the Internet or e-commerce. It is possible that general business regulations and laws, or those specifically governing the Internet or e-commerce, may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another and may conflict with other rules or our practices. We cannot be sure that our practices have complied, comply or will comply fully with all such laws and regulations. Any failure, or perceived failure, by us to comply with any of these laws or regulations could result in damage to our reputation, a loss in business and proceedings or actions against us by governmental entities or others. Any such proceeding or action could hurt our reputation, force us to spend significant amounts in defense of these proceedings, distract our management, increase our costs of doing business and decrease the use of our sites by consumers and suppliers and may result in the imposition of monetary liability. We may also be contractually liable to indemnify and hold harmless third parties from the costs or consequences of non-compliance with any such laws or regulations. In addition, it is possible that governments of one or more countries may seek to censor content available on our sites or may even attempt to completely block access to our sites. Adverse legal or regulatory developments could substantially harm our business. In particular, in the event that we are restricted, in whole or in part, from operating in one or more countries, our ability to retain or increase our consumer base may be adversely affected, and we may not be able to maintain or grow our net sales and expand our business as anticipated.

We are subject to payment-related risks.

We accept payments using a variety of methods, including credit cards, debit cards, gift cards, PayPal, cash and bank checks. For existing and future payment methods we offer to our customers, we may become subject to additional regulations and compliance requirements (including obligations to implement enhanced authentication processes that could result in increased costs and reduce the ease of use of certain payment methods), as well as fraud. For certain payment methods, including credit and debit cards, we pay interchange and other fees, which may increase over time, raising our operating costs and lowering our profitability. We rely on third-party service providers for payment processing services, including the processing of credit and debit cards. Our business may be negatively affected if these third-party service providers become unwilling or unable to provide these services to us. We are also subject to payment card brand operating rules, including data security rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with these rules or requirements, or if our data security systems are breached or compromised, we may be liable for card issuing

 

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banks’ costs, subject to fines and higher transaction fees and/or lose our ability to accept credit and debit card payments from our customers and process electronic funds transfers or facilitate other types of payments. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.

Failure to comply with the U.S. Foreign Corrupt Practices Act, other applicable anti-corruption and anti-bribery laws, and applicable trade control laws could subject us to penalties and other adverse consequences.

In fiscal 2018, we sourced our products from approximately 20 countries, with products sourced from mainland China representing 60% of our merchandise and products sourced from Vietnam and Indonesia representing an additional 20% of our merchandise during that time. We also sell our products in several countries outside of the United States. Our operations are subject to the U.S. Foreign Corrupt Practices Act (the “FCPA”), as well as the anti-corruption and anti-bribery laws in the countries where we do business. The FCPA prohibits covered parties from offering, promising, authorizing or giving anything of value, directly or indirectly, to a “foreign government official” with the intent of improperly influencing the official’s act or decision, inducing the official to act or refrain from acting in violation of lawful duty, or obtaining or retaining an improper business advantage. The FCPA also requires publicly traded companies to maintain records that accurately and fairly represent their transactions, and to have an adequate system of internal accounting controls. In addition, other applicable anti-corruption laws prohibit bribery of domestic government officials, and some laws that may apply to our operations prohibit commercial bribery, including giving or receiving improper payments to or from non-government parties, as well as so-called “facilitation” payments. In addition, we are subject to U.S. and other applicable trade control regulations that restrict with whom we may transact business, including the trade sanctions enforced by the U.S. Treasury, Office of Foreign Assets Control (OFAC).

While we have implemented policies, internal controls and other measures reasonably designed to promote compliance with applicable anticorruption and anti-bribery laws and regulations, and certain safeguards designed to ensure compliance with U.S. trade control laws, our employees or agents may engage in improper conduct for which we might be held responsible. Any violations of these anti-corruption or trade controls laws, or even allegations of such violations, can lead to an investigation and/or enforcement action, which could disrupt our operations, involve significant management distraction, and lead to significant costs and expenses, including legal fees. If we, or our employees or agents acting on our behalf, are found to have engaged in practices that violate these laws and regulations, we could suffer severe fines and penalties, profit disgorgement, injunctions on future conduct, securities litigation, bans on transacting government business, delisting from securities exchanges and other consequences that may have a material adverse effect on our business, financial condition and results of operations. In addition, our brand and reputation, our sales activities or our stock price could be adversely affected if we become the subject of any negative publicity related to actual or potential violations of anti-corruption, anti-bribery or trade control laws and regulations.

Our failure to find store employees that reflect our brand image and embody our culture could have a material adverse effect on our business, financial condition and results of operations.

Our success depends in part upon our ability to attract, motivate and retain a sufficient number of store employees, including store managers, who understand and appreciate our culture and customers, and are able to adequately and effectively represent this culture and establish credibility with our customers. The store employee turnover rate in the specialty retail industry is generally high. Labor shortages and excessive store employee turnover will result in higher employee costs associated with finding, hiring and training new store employees. If we are unable to attract, hire and retain store personnel capable of consistently providing exceptional customer service, as demonstrated by their enthusiasm for our culture and brand, understanding of our clients and knowledge of the merchandise we offer, our ability to open new stores and operate existing stores may be impaired and our performance and brand image may be negatively impacted. Competition for such qualified individuals and wage increases by other retailers could require us to pay higher wages to attract a sufficient

 

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number of employees. Any such failure to meet our staffing needs or any material increases in employee turnover rates could have a material adverse effect on our business, financial condition and results of operations.

Changes to estimates related to our property, fixtures and equipment or results of operations that are lower than our current estimates at certain store locations may cause us to incur impairment charges on certain long-lived assets, which may have a material adverse effect on our business, financial condition and results of operations.

In accordance with accounting guidance as it relates to the impairment of long-lived assets, we make certain estimates and projections with regard to individual store operations, as well as our overall performance, in connection with our impairment analyses for long-lived assets. When impairment triggers are deemed to exist for any location, the estimated undiscounted future cash flows are compared to its carrying value. If the carrying value exceeds the undiscounted cash flows, an impairment charge equal to the difference between the carrying value and the fair value is recorded. The projections of future cash flows used in these analyses require the use of judgment and a number of estimates and projections of future results of operations. If actual results differ from our estimates, additional charges for asset impairments may be required in the future. If future impairment charges are significant, it may have a material adverse effect on our business, financial condition and results of operations.

Changes in generally accepted accounting principles in the United States could have a material adverse effect on our previously reported results of operations.

Generally accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board (the “FASB”), the SEC, and various bodies formed to promulgate and to interpret appropriate accounting principles. For example, in February 2016 and July 2018, pronouncements were issued with respect to the accounting for leases. Effective for fiscal years beginning after December 15, 2018, the pronouncements require lessees to recognize right-of-use lease assets (“ROU assets”) and right-of-use lease liabilities (“ROU liabilities”) for leases with terms of more than one year. The ROU liabilities are measured as the present value of the lease obligations. The ROU assets reflect the amount of the ROU liabilities less lease-related deferred credits. We adopted the pronouncements in the first quarter of fiscal 2019 using the effective date method whereby initial application occurs on the date of adoption with comparative periods unchanged. Upon adoption of the new standard, we recorded a significant gross-up to the balance sheet, including ROU assets of $121.1 million and ROU liabilities of $148.2 million. We utilized the package of practical expedients permitted by the transition guidance, which allowed for a carryforward of our identification of leases, historical lease classification and initial direct costs for existing leases. We elected to use hindsight in determining the lease term. Future changes such as these to accounting principles or interpretations could have a significant effect on our previously reported results of operations and could affect the reporting of transactions completed before the announcement of a change.

Climate change and related regulatory responses may adversely impact our business.

There is increasing concern that a gradual increase in global average temperatures due to increased concentration of carbon dioxide and other greenhouse gases in the atmosphere will cause significant changes in weather patterns around the globe and an increase in the frequency and severity of natural disasters. Changes in weather patterns and an increased frequency, intensity and duration of extreme weather conditions could, among other things, adversely impact the cultivation of cotton, which is a key resource in the production of our products, disrupt the operation of our supply chain and the productivity of our contract manufacturers, increase our product costs and impact the types of apparel products that consumers purchase. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations.

In many countries, governmental bodies are increasingly enacting legislation and regulations in response to the potential impacts of climate change. These laws and regulations, which may be mandatory, have the

 

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potential to impact our operations directly or indirectly as a result of required compliance by us, our suppliers and our contract manufacturers. In addition, we may choose to take voluntary steps to mitigate our impact on climate change. As a result, we may experience increases in energy, production, transportation and raw material costs, capital expenditures or insurance premiums and deductibles. Inconsistency of legislation and regulations among jurisdictions may also affect the costs of compliance with such laws and regulations. Any assessment of the potential impact of future climate change legislation, regulations or industry standards, as well as any international treaties and accords, is uncertain given the wide scope of potential regulatory change in the countries in which we operate.

Further, extreme weather conditions in the areas in which our stores are located may cause a greater number of store closures or lost revenue than we have historically experienced. Our business is also susceptible to unseasonable weather conditions. For example, extended periods of unseasonably warm temperatures during the winter season or cool weather during the summer season could render a portion of our inventory incompatible with those unseasonable conditions, which could adversely affect our ability to execute our ability to effectively offer seasonal merchandise. Reduced revenue from extreme or prolonged unseasonable weather conditions could adversely affect our business.

We are subject to insurance-related risks.

We believe that we have, and will continue to maintain following the Reorganization, insurance customary for businesses of our size and type, including liability insurance, property and business interruption insurance, directors’ and officers’ insurance, and cyber insurance, with deductibles, self-insured retentions, limits of liability and similar provisions. However, there is no guarantee that our insurance coverage will be sufficient, or that insurance proceeds will be paid to us on a timely basis. In addition, there are types of losses we may incur but against which we cannot be insured or which we believe are not economically reasonable to insure. If we incur these losses and they are material, it may have a material adverse effect on our business, financial condition and results of operations. Also, certain material events may result in sizable losses for the insurance industry and materially adversely impact the availability of adequate insurance coverage or result in significant premium increases. Accordingly, we may elect to self-insure, accept higher deductibles or reduce the amount of coverage in response to such market changes.

Risks Related to the Reorganization

Our substantial indebtedness following the completion of the Reorganization, as well as the documents governing such indebtedness, may adversely affect our financial health and operating flexibility.

We will incur a substantial amount of new indebtedness in connection with the Reorganization, and would have had approximately $                million of outstanding indebtedness as of February 2, 2019, pro forma for the Reorganization. This substantial amount of indebtedness could have important consequences to us, including:

This substantial amount of indebtedness could have important consequences to us, including:

 

   

limiting our ability or increasing the costs to refinance our indebtedness;

 

   

limiting our ability to borrow additional amounts for working capital, capital expenditures, debt service requirements, execution of our business strategy or other purposes limiting our ability to adjust to changing market conditions and placing us at a competitive disadvantage compared to our competitors who are not as highly leveraged;

 

   

limiting our ability to use operating cash flow in other areas of our business because we must dedicate a substantial portion of these funds to service debt;

 

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increasing our vulnerability to general adverse economic and industry conditions, including increases in interest rates; and

 

   

limiting our ability to capitalize on business opportunities and to react to competitive pressures.

We also have, and will continue to have, significant lease obligations. As of February 2, 2019, our minimum annual rental obligations under long-term operating leases for fiscal 2019 and fiscal 2020 are $34.2 million and $32.0 million, respectively.

The financing agreements governing the new indebtedness we expect to incur in connection with the Reorganization will contain various covenants and restrictions, including                .

These restrictions could affect our ability to operate our business and may limit our ability to react to market conditions or take advantage of potential business opportunities as they arise. For example, such restrictions could adversely affect our ability to finance our operations, make strategic acquisitions, investments or alliances, restructure our organization or finance our capital needs. Additionally, our ability to comply with these covenants and restrictions may be affected by events beyond our control. These include prevailing economic, financial and industry conditions.

The historical consolidated financial data of Chinos Holdings and the supplemental historical combined financial data of the Madewell business are not necessarily representative of the results we would have achieved after giving effect to the Reorganization and may not be a reliable indicator of our future results.

The historical consolidated financial data of Chinos Holdings and the supplemental historical combined financial data of the Madewell business included in this prospectus do not reflect the financial condition, results of operations or cash flows we would have achieved as a standalone company during the periods presented or those we will achieve in the future for the following reasons, among others:

 

   

the historical consolidated financial data of Chinos Holdings includes the financial condition, results of operations and cash flows of the J.Crew business, which will be spun off and will not be a part of our business after the Reorganization;

 

   

the historical consolidated financial data of Chinos Holdings and the supplemental historical combined financial data of the Madewell business do not reflect the Reorganization or the tax impact thereof or one-time expenses relating to the Reorganization;

 

   

the supplemental historical combined financial data of the Madewell business reflects expense allocations for certain support functions that are provided on a centralized basis within J.Crew, such as expenses for, among others, finance, information technology, human resources, corporate occupancy, legal, production and sourcing, supply chain, store and e-commerce operations and executive leadership that may be materially higher or lower than the comparable expenses we will occur under the Transition Services Agreement, or will incur in the future as a standalone, publicly traded company;

 

   

our cost of debt and our capital structure will be different from that reflected in the historical consolidated financial data of Chinos Holdings because they do not give effect to the repayment of the pre-Reorganization debt and the incurrence of new indebtedness in connection with the Reorganization;

 

   

our cost of debt and our capital structure will be different from that reflected in the supplemental historical combined financial statements of the Madewell business because they not include an allocation of debt or interest expense from Chinos Holdings because we are not considered the

 

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obligor of such debt for accounting purposes and because the borrowings were not directly attributable to our business and they do not reflect the incurrence of new indebtedness in connection with the Reorganization;

 

   

significant increases may occur in our cost structure as a result of this offering, including costs related to public company reporting, investor relations and compliance with the Sarbanes-Oxley Act; and

 

   

this offering may have a material effect on our customers and other business relationships, including supplier relationships, and may result in the loss of preferred pricing available by virtue of our reduced relationship with J.Crew.

Our financial condition and future results of operations, after giving effect to the Reorganization, will be materially different from amounts reflected in the historical consolidated financial statements of Chinos Holdings and the supplemental historical combined financial statements of the Madewell business included elsewhere in this prospectus. As a result of the Reorganization, it may be difficult for investors to compare our future results to historical results or to evaluate our relative performance or trends in our business.

We and our subsidiaries may not be able to generate sufficient cash to service all of our indebtedness, may not be able to refinance all of our indebtedness before it becomes due and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability and our subsidiaries’ ability to make scheduled payments on or refinance our debt obligations depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business, legislative, regulatory and other factors beyond our control. We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal and interest on our indebtedness. In addition, because we derive a substantial portion of our operating income from our subsidiaries, our ability to repay our debt depends upon the performance of our subsidiaries, their ability to dividend or distribute funds to us and our receipt of funds.

We and our subsidiaries may not be able to generate cash flows from the operations on an amount sufficient to fund our liquidity needs. If our cash flows and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and could be forced to reduce or delay investments and capital expenditures, or to dispose of material assets or operations, seek additional debt or equity capital or restructure or refinance our indebtedness. We may not be able to effect any such alternative measures on commercially reasonable terms or at all and, even if successful, those alternative actions may not allow us to meet our scheduled debt service obligations. The instruments that will govern our indebtedness may restrict our ability pursue these alternative measures. These alternatives measures may not be successful and may not permit us or our subsidiaries to meet scheduled debt service obligations.

The unaudited pro forma consolidated financial information in this prospectus is based on estimates and assumptions that may prove to be materially different from our actual experience.

In preparing the unaudited pro forma consolidated financial information included elsewhere in this prospectus, we have made certain adjustments to the historical combined financial information based upon currently available information and upon estimates and assumptions that our management believes are reasonable in order to reflect, on a pro forma basis, the impact of the Reorganization. However, these estimates are predicated on assumptions, judgments and other information which are inherently uncertain.

These estimates and assumptions used in the preparation of the unaudited pro forma consolidated financial information in this prospectus may be materially different from our actual financial condition and results of operation. The unaudited pro forma consolidated financial information included elsewhere in this

 

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prospectus does not purport to represent what our results of operations would actually have been had we operated as a standalone public company during the periods presented, nor do the pro forma data give effect to any events other than those discussed in the unaudited pro forma consolidated financial information and related notes. See “Additional Information Related to Chinos Holdings—Unaudited Pro Forma Consolidated Financial Data of Chinos Holdings.”

As a result of the Separation, we will lose J.Crew’s brand, reputation, capital base and other resources, and may experience difficulty operating as a standalone company.

We believe our association with J.Crew has contributed to our building relationships with our customers due to J.Crew’s globally recognized brand and perceived high-quality products. The Separation could adversely affect our ability to attract and retain customers, which could result in reduced sales of our products or limit our growth.

The loss of J.Crew’s scale, capital base and customer and supplier relationships may also prompt suppliers to reprice, modify or terminate their relationships with us. In addition, J.Crew’s reduction of its ownership of our company could potentially cause some of our existing agreements and licenses to be terminated. We cannot predict with certainty the effect that the Reorganization will have on our business, our clients, vendors or other persons.

Further, because we have not operated the Madewell business as a standalone, publicly traded company in the past, we may have difficulty doing so. We may need to acquire assets and resources in addition to those provided by J.Crew to our company, and in connection with the Separation, may also face difficulty in separating our assets from J.Crew’s assets and integrating newly acquired assets into our business. Our business, financial condition and results of operations could be materially adversely affected if we have difficulty operating as a standalone, publicly traded company, fail to acquire assets that prove to be important to our operations or incur unexpected costs in separating our assets from J.Crew’s assets or integrating newly-acquired assets.

J.Crew may compete with us.

J.Crew will not be restricted from competing with us in the specialty retail industry and it may have a competitive advantage over us. This may have a material adverse effect on our business, financial condition and results of operations.

We will incur significant charges in connection with this offering and the Reorganization transactions and incremental costs as a standalone public company.

We will need to replicate or replace certain functions, systems and infrastructure to which we will no longer have the same access after this offering. We may also need to make investments or hire additional employees to operate without the same access to J.Crew’s existing operational and administrative infrastructure. These initiatives may be costly to implement. Due to the scope and complexity of the underlying projects relative to these efforts, the amount of total costs could be materially higher than our estimate and the timing of the incurrence of these costs is subject to change.

J.Crew currently performs or supports many important corporate functions for our company. The supplemental historical combined financial statements of the Madewell business reflect charges for these services on an allocated basis. Following this offering, many of these services will be governed by the Transition Services Agreement. Under the Transition Services Agreement, we will be able to use these J.Crew services for a fixed term established on a service-by-service basis.

Additionally, after the Transition Services Agreement terminates, we may be unable to sustain the services at the same levels or obtain the same benefits as when we were receiving such services and benefits

 

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from J.Crew. When we begin to operate these functions separately, if we do not have our own adequate systems and business functions in place, or are unable to obtain them from other providers, we may not be able to operate our business effectively or at comparable costs, and our profitability may decline. In addition, we have historically received informal support from J.Crew, which may not be addressed in our Transition Services Agreement. The level of this informal support will diminish or be eliminated following this offering.

In addition, the supplemental historical combined financial statements of the Madewell business include the Allocated Costs, which have historically been held at the Chinos Holdings corporate level but which are specifically identifiable or attributable to the businesses being transferred to us in connection with the Separation. The value of the assets and liabilities we assume in connection with the Reorganization could ultimately be materially different than such attributions, which could have a material adverse effect on our financial condition. Similarly, our actual costs and expenses as a standalone company could be materially higher than is currently reflected in the supplemental historical combined financial statements of the Madewell business.

In connection with the Separation, J.Crew will indemnify us and we will indemnify J.Crew for certain liabilities. There can be no assurance that the indemnities from J.Crew will be sufficient to insure us against the full amount of such liabilities.

The Transition Services Agreement that we will enter into with one or more J.Crew entities in connection with the Separation will provide, among other things, that J.Crew generally will indemnify us for losses that we incur arising out of, or relating to, the businesses conducted by J.Crew and losses that we incur arising out of, or relating to, J.Crew’s breach of                 . In addition, we generally will indemnify J.Crew for losses that J.Crew incurs arising out of, or relating to, our business and losses J.Crew incurs arising out of, or relating to, our breach of                 . We may not be able to recover any or all of the amount of indemnified losses from J.Crew should it be financially unable to perform under its indemnification obligations due to financial distress, or other reasons. In addition, we may be required to make substantial payments under our indemnity obligations to J.Crew, which could have a material adverse effect on our business, financial condition and results of operations.

We may be subject to litigation related to the Reorganization.

Litigation frequently follows the announcement of transformative business transactions and stockholders in J.Crew may seek damages or other remedies in connection with the Reorganization and this offering. Any such litigation could be expensive and divert management’s attention and resources, which could have a material adverse effect on our business, financial condition and results of operations.

Risks Related to Our Initial Public Offering and Ownership of Our Common Stock

There is no existing market for our common stock and an active, liquid trading market for our common stock may not develop.

Prior to this offering, there has been no public market for our common stock. We cannot predict the extent to which investor interest in our Company will lead to the development of an active trading market or how liquid that market may become. If an active trading market does not develop, you may have difficulty selling any of our shares that you purchase. The initial public offering price of our common stock will be determined by negotiation between us and the underwriters, and may not be indicative of prices that will prevail after the completion of this offering. The market price of our common stock may decline below the initial public offering price, and you may not be able to resell your shares at, or above, the initial public offering price.

The price of our common stock may be volatile and you could lose all or part of your investment.

Securities markets worldwide have experienced in the past, and are likely to experience in the future, significant price and volume fluctuations. This market volatility, as well as general economic, market, or political

 

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conditions could reduce the market price of our common stock, regardless of our results of operations. The trading price of our common stock is likely to be highly volatile and could be subject to wide price fluctuations in response to various factors, including, among other things, the risk factors described herein and other factors beyond our control. Factors affecting the trading price of our common stock could include:

 

   

market conditions in the broader stock market;

 

   

actual or anticipated variations in our quarterly results of operations;

 

   

developments in our industry in general;

 

   

variations in results of operations of similar companies;

 

   

introduction of new products by us or our competitors;

 

   

issuance of new, negative, or changed securities analysts’ reports or recommendations or estimates;

 

   

sales, or anticipated sales, of our stock, including sales by our officers, directors, and significant stockholders;

 

   

additions or departures of key personnel;

 

   

regulatory or political developments;

 

   

announcements, media reports or other public forum comments related to litigation, claims or reputational charges against us;

 

   

guidance, if any, that we provide to the public, any changes in this guidance, or our failure to meet this guidance;

 

   

the development and sustainability of an active trading market for our common stock;

 

   

investor perceptions of the investment opportunity associated with our common stock relative to other investment alternatives;

 

   

other events or factors, including those resulting from system failures and disruptions, earthquakes, hurricanes, war, acts of terrorism, other natural disasters or responses to these events;

 

   

changes in accounting principles;

 

   

share-based compensation expense under applicable accounting standards;

 

   

litigation and governmental investigations; and

 

   

changing economic conditions.

These and other factors may cause the market price and demand for shares of our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively affect the liquidity of our common stock. In addition, in the past, when the market price of a stock has been volatile, holders of that stock sometimes have instituted securities class action litigation against the company that issued the stock. Securities litigation against us, regardless of the merits or outcome, could result in substantial costs and divert the time and attention of our management from our business, which could have a material adverse effect on our business, financial condition and results of operations.

 

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If securities or industry analysts do not publish research or reports about our business or publish negative reports, our stock price could decline.

The trading market for our common stock will be influenced in part by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. If one or more of these analysts initiate research with an unfavorable rating or downgrade our common stock, provide a more favorable recommendation about our competitors, publish inaccurate or unfavorable research about our business or cease coverage of our company, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Future sales of our common stock, or the perception in the public markets that these sales may occur, could cause the market price for our common stock to decline.

Upon completion of this offering, there will be                shares of our common stock outstanding. All shares of common stock sold in this offering will be freely transferable without restriction or further registration under the Securities Act. At the time of this offering, we also will have                registered shares of common stock reserved for issuance under our equity incentive plans of which options to purchase                 shares of common stock are outstanding and options to purchase                shares of common stock and restricted stock units representing                 shares of common stock will be issued in connection with this offering, which shares may be issued upon issuance and once vested, subject to any applicable lock-up restrictions then in effect. We cannot predict the effect, if any, that market sales of shares of our common stock or the availability of shares of our common stock for sale will have on the market price of our common stock prevailing from time to time. Sales of substantial amounts of shares of our common stock in the public market, or the perception that those sales will occur, could cause the market price of our common stock to decline. Of the remaining shares of common stock outstanding,                 will be restricted securities within the meaning of Rule 144 under the Securities Act and subject to certain restrictions on resale following the completion of this offering. Restricted securities may be sold in the public market only if they are registered under the Securities Act, or are sold pursuant to an exemption from registration such as Rule 144 or Rule 701, as described in “Other Information Related to this Offering—Shares Eligible for Future Sale.”

We, each of our officers and directors and certain other holders of our common stock have agreed that (subject to certain exceptions), for a period of 180 days from the date of this prospectus, we and they will not, without the prior written consent of                 , dispose of or hedge any shares or any securities convertible into or exchangeable for our common stock.                 , in their sole discretion, may release any of the securities subject to these lock-up agreements at any time, which, in the case of officers and directors, shall be with notice. See “Other Information Related to This Offering—Underwriting.” Following the expiration of the applicable lock-up period, all of the issued and outstanding shares of our common stock will be eligible for future sale, subject to the applicable volume, manner of sale, holding period and other limitations of Rule 144. See “Other Information Related to This Offering—Shares Eligible for Future Sale” for a discussion of the shares of common stock that may be sold into the public market in the future.

Because we do not intend to pay cash dividends in the foreseeable future, you may not receive any return on investment unless you are able to sell your common stock for a price greater than your purchase price.

We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or to pay any dividends in the foreseeable future. Consequently, stockholders must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. We do not intend in the foreseeable future to pay any dividends to holders of our common stock. We currently intend to retain our future earnings, if any, for the foreseeable future to repay indebtedness and to support our general corporate purposes. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future, and the success of an investment in shares of our common stock will depend upon any future appreciation in their value. There is no guarantee that shares of our

 

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common stock will appreciate in value or even maintain the price at which investors have purchased their shares. However, the payment of future dividends will be at the discretion of our Board, subject to applicable law, and will depend on, among other things, our earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual restrictions that apply to the payment of dividends, and other considerations that our Board deems relevant. See “Dividend Policy.” As a consequence of these limitations and restrictions, we may not be able to make the payment of dividends on our common stock.

If you purchase shares of our common stock in our initial public offering, you will experience substantial and immediate dilution.

The initial public offering price per share is substantially higher than the pro forma net tangible book value per share immediately after this offering. As a result, you will pay a price per share that substantially exceeds the book value of our assets after subtracting the book value of our liabilities. Based on our net tangible book value as of February 2, 2019, and the initial public offering price of $         per share, you will incur immediate and substantial dilution in the amount of $        per share. See “Dilution.”

As a standalone public company, we may expend additional time and resources to comply with rules and regulations that do not currently apply to us, and failure to comply with such rules may lead investors to lose confidence in our financial data.

As a standalone public company, we will be subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act and regulations of the NYSE or NASDAQ. We will have to establish procedures and practices required as a separate, standalone public company. Establishing such procedures and practices will increase our legal, accounting and financial compliance costs, will make some activities more difficult, time-consuming and costly and could be burdensome on our personnel, systems and resources. We will devote significant resources to address these public company requirements, including compliance programs and investor relations, as well as our financial reporting obligations. As a result, we have and will continue to incur significant legal, accounting and other expenses that we did not previously incur to comply with these rules and regulations. Furthermore, the need to establish the corporate infrastructure necessary for a standalone public company may divert some of management’s attention from operating our business and implementing our strategy. However, the measures we take may not be sufficient to satisfy our obligations as a public company. In addition, we cannot predict or estimate the amount of additional costs we may incur in order to comply with these requirements.

We have made, and will continue to make, changes to our internal controls and procedures for financial reporting and accounting systems to meet our reporting obligations. In particular, as a public company, our management will be required to conduct an annual evaluation of our internal controls over financial reporting and include a report of management on our internal controls in our annual reports on Form 10-K. Under current rules, we will be subject to these requirements beginning with our annual report on Form 10-K for fiscal 2020. In addition, we will be required to have our independent registered public accounting firm attest to the effectiveness of our internal controls over financial reporting beginning with our annual report on Form 10-K for fiscal 2020. If we are unable to conclude that we have effective internal controls over financial reporting, or if our registered public accounting firm is unable to provide us with an attestation and an unqualified report as to the effectiveness of our internal controls over financial reporting, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock.

Anti-takeover protections in our amended and restated certificate of incorporation, our amended and restated bylaws or our contractual obligations may discourage or prevent a takeover of our Company, even if an acquisition would be beneficial to our stockholders.

Provisions contained in our amended and restated certificate of incorporation and amended and restated bylaws, as amended, as well as provisions of the Delaware General Corporation Law (the “DGCL”), could delay

 

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or make it more difficult to remove incumbent directors or could impede a merger, takeover or other business combination involving us or the replacement of our management, or discourage a potential investor from making a tender offer for our common stock, which, under certain circumstances, could reduce the market value of our common stock, even if it would benefit our stockholders.

In addition, our Board has the authority to cause us to issue, without any further vote or action by the stockholders, up to                shares of preferred stock, par value $0.01 per share, in one or more series, to designate the number of shares constituting any series, and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, voting rights, rights and terms of redemption, redemption price, or prices and liquidation preferences of such series. The issuance of shares of preferred stock or the adoption of a stockholder rights plan may have the effect of delaying, deferring or preventing a change in control of our Company without further action by the stockholders, even where stockholders are offered a premium for their shares. See “Other Information Related to this Offering—Description of Capital Stock—Anti-takeover Provisions.”

 

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements, including, without limitation, statements concerning the conditions of the specialty retail industry and our operations, performance and financial condition, including in particular, statements relating to our business, growth strategies, product development efforts, and future expenses. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects,” and similar references to future periods, or by the inclusion of forecasts or projections. Examples of forward-looking statements include, but are not limited to, statements we make regarding the outlook for our future business and financial performance, such as those contained in “Prospectus Summary,” “Risk Factors,” “Additional Information Related to Chinos Holdings—Management’s Discussion and Analysis of Financial Condition and Results of Operations of Chinos Holdings,” “Additional Information Related to Chinos Holdings—Chinos Holdings Business,” “Additional Information Related to the Madewell Business—Supplemental Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Madewell Business” and “Additional Information Related to the Madewell Business—Madewell Business.”

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy, and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national, or global political, economic, business, competitive, market, and regulatory conditions and the following:

 

   

Our failure to predict fashion trends or react to changing consumer preferences in a timely manner.

 

   

Damage to our brand or reputation due to negative publicity.

 

   

Heightened competition from other specialty retailers, including those with a similar focus on denim, certain of which have substantially greater resources than we do.

 

   

Our ability to enhance and expand our omnichannel capabilities through the further integration our in store and e-commerce channels.

 

   

Our ability to execute on our real estate strategy.

 

   

Disruptions to the operations of our order and distribution centers or failure of third-party vendors.

 

   

Changes in U.S. foreign trade policy, the imposition of tariffs or trade disputes.

 

   

The impact of global economic conditions affecting the production or transportation costs of our products.

 

   

Our dependence on our relationship with J.Crew for certain operational and corporate functions following the Separation and J.Crew’s ability to perform these functions.

 

   

Changes in, or failure to comply with, government regulation of the Internet and e-commerce, data privacy, anti-corruption and anti-bribery laws.

 

   

Our substantial indebtedness following the completion of the Reorganization.

 

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The loss of our access to certain of J.Crew’s brand, services, reputation, capital base and other resources following the Separation.

 

   

The other factors set forth under “Risk Factors.”

See “Risk Factors” for a further description of these and other factors. Although we have attempted to identify important risk factors, there may be other risk factors not presently known to us or that we presently believe are not material that could cause actual results and developments to differ materially from those made in or suggested by the forward-looking statements contained in this prospectus. If any of these risks materialize, or if any of the above assumptions underlying forward-looking statements prove incorrect, actual results and developments may differ materially from those made in or suggested by the forward-looking statements contained in this prospectus. For the reasons described above, we caution you against relying on any forward-looking statements, which should also be read in conjunction with the other cautionary statements that are included elsewhere in this prospectus. Any forward-looking statement made by us in this speaks only as of the date on which we make it. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update or to revise any forward-looking statement, whether as a result of new information, future developments, or otherwise, except as may be required by law. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless specifically expressed as such, and should be viewed as historical data.

 

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THE REORGANIZATION

Prior to the completion of this offering, Chinos Holdings is a holding company that is the ultimate parent of various subsidiaries that operate the Madewell business and the J.Crew business.

Concurrent with the completion of this offering, Chinos Holdings will undergo a series of transactions pursuant to which it will:

 

   

effect the Separation, pursuant to which it will spinoff the J.Crew business to its stockholders, after which (i) the J.Crew business will cease to be a part of Chinos Holdings and (ii) certain pre-Separation indebtedness of Chinos Holdings will be an obligation of the J.Crew business and will not be an obligation of Chinos Holdings on a consolidated basis;

 

   

enter into the Transition Services Agreement and other related agreements, pursuant to which entities operating the J.Crew business will continue to provide us with certain administrative capabilities for a specified period of time following the Separation;

 

   

exchange shares of its common stock for certain of its pre-Separation indebtedness;

 

   

incur new debt obligations and use the net proceeds it receives therefrom together with the proceeds from this offering to repay its remaining pre-Separation indebtedness; and

 

   

convert its preferred stock into common stock.

We refer to these transactions, together with this offering, collectively as the “Reorganization.” See “Other Information Related to this Offering—Certain Relationships and Related Party Transactions—Relationship with J.Crew” for additional information.

After the Reorganization, Chinos Holdings will no longer directly or indirectly own or operate the J.Crew business and the only business of Chinos Holdings will be the Madewell business. Accordingly, the Madewell business is the business in which you are investing if you buy shares of common stock in this offering. In addition, Chinos Holdings will not be an obligor or guarantor of, or have any assets pledged as collateral for, any of its pre-Reorganization indebtedness after the Reorganization.

We will provide further information regarding the Reorganization in subsequent amendments to the registration statement, of which this prospectus is a part, and prior to the completion of this offering.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from this offering will be approximately $                million, or approximately $                million if the underwriters exercise in full their option to purchase additional shares, assuming an initial public offering price of $                per share (the midpoint of the estimated public offering price range set forth on the cover page of this prospectus), after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

We intend to use the net proceeds from this offering, together with proceeds from debt obligations we will incur in connection with the Reorganization, to repay certain of Chinos Holdings’ pre-Reorganization indebtedness and the remainder for general corporate purposes. We will provide further information regarding the debt to be repaid using the proceeds of this offering in subsequent amendments to the registration statement, of which this prospectus is a part, and prior to the completion of this offering.

Assuming no exercise of the underwriters’ option to purchase additional shares, each $1.00 increase (decrease) in the assumed initial public offering price of $                 per share (the midpoint of the estimated public offering price range set forth on the cover page of this prospectus) would increase (decrease) the net proceeds to us from this offering by $                 million, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated expenses payable by us. Similarly, an increase (decrease) of one million shares of common stock sold in this offering by us would increase (decrease) our net proceeds by $                , assuming the initial public offering price of $                per share (the midpoint of the estimated public offering price range set forth on the cover page of this prospectus), remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

The foregoing represents our current intentions with respect to the use and allocation of the net proceeds of this offering based upon our present plans and business conditions, but our management will have significant flexibility and discretion in applying the net proceeds. The occurrence of unforeseen events or changed business conditions could result in application of the net proceeds of this offering in a manner other than as described in this prospectus.

 

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DIVIDEND POLICY

We do not currently intend to pay cash dividends on our common stock in the foreseeable future. However, in the future, subject to the factors described below and our future liquidity and capitalization, we may change this policy and choose to pay dividends.

In addition, under Delaware law, our board of directors may declare dividends only to the extent of our surplus (which is defined as total assets at fair market value minus total liabilities, minus statutory capital) or, if there is no surplus, out of our net profits for the then current and/or immediately preceding fiscal year.

Any future determination to pay dividends will be at the discretion of our board of directors and will take into account:

 

   

restrictions in our debt instruments;

 

   

general economic business conditions;

 

   

our earnings, financial condition and results of operations;

 

   

our capital requirements;

 

   

our prospects;

 

   

legal restrictions; and

 

   

such other factors as our board of directors may deem relevant.

See “Risk Factors—Risks Related to Our Initial Public Offering and Ownership of Our Common Stock—Because we do not intend to pay cash dividends in the foreseeable future, you may not receive any return on investment unless you are able to sell your common stock for a price greater than your purchase price,” “Risk Factors—Risks Related to Our Initial Public Offering and Ownership of Our Common Stock,” “Additional Information Related to the Madewell Business—Supplemental Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Madewell Business—Liquidity and Capital Resources,” “Additional Information Related to the Madewell Business—Description of Material Indebtedness of Madewell” and “Other Information Related to this Offering—Description of Capital Stock.”

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

CAPITALIZATION

The following table sets forth our cash and cash equivalents and our capitalization as of February 2, 2019:

 

   

on an actual basis for Chinos Holdings;

 

   

on a pro forma basis to give effect to (i) the Separation and (ii) the Transition Services Agreement, as if such transactions had occurred on February 2, 2019; and

 

   

on a pro forma, as adjusted basis to further reflect (i) our receipt of the estimated net proceeds from the sale of common stock by us in the offering at an assumed initial public offering price of $             per share (the midpoint of the range appearing on the cover page of this prospectus), after deducting the assumed underwriting discount and commissions and estimated fees and expenses payable by us; (ii) the incurrence of new indebtedness in connection with the Reorganization; (iii) the application of the net proceeds of this offering together with the net proceeds from the incurrence of new indebtedness to repay certain pre-Reorganization indebtedness of Chinos Holdings, as described in “Use of Proceeds;” and (iv) the exchange of shares of Chinos Holdings common stock for certain of its pre-Reorganization indebtedness, as if such transactions had occurred on February 2, 2019.

The information below is not necessarily indicative of what the cash and cash equivalents and capitalization of Chinos Holdings would have been had the Reorganization been completed as of February 2, 2019. In addition, it is not indicative of our future cash and cash equivalents and capitalization.

 

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This table is derived, in part, from, and should be read in conjunction with the supplemental historical combined financial statements of the Madewell business and our unaudited pro forma consolidated financial statements and the notes thereto included elsewhere in this prospectus, and should be read in conjunction with “Basis of Financial Presentation” “Use of Proceeds,” “Additional Information Related to Chinos Holdings—Selected Historical Consolidated Financial Data of Chinos Holdings,” “Additional Information Related to Chinos Holdings—Unaudited Pro Forma Consolidated Financial Data of Chinos Holdings,” “Additional Information Related to the Madewell Business—Supplemental Selected Historical Combined Financial Data of the Madewell Business,” “Additional Information Related to Chinos Holdings—Management’s Discussion and Analysis of Financial Condition and Results of Operations of Chinos Holdings,” “Other Information Related to this Offering—Description of Capital Stock,” the historical consolidated financial statements of Chinos Holdings and the notes thereto included elsewhere in this prospectus and the supplemental historical combined financial statements of the Madewell business and notes thereto appearing elsewhere in this prospectus.

 

    

As of February 2, 2019

 
    

Chinos Holdings

Actual

   

Chinos Holdings

Pro Forma

    

Chinos Holdings

Pro Forma, As

Adjusted

 
(Dollars in millions)                    

Cash and cash equivalents

   $ 28,055     $        $    
  

 

 

   

 

 

    

 

 

 

Long-term debt, net(b)

     1,766,919       

Mezzanine equity:

       

Series A preferred stock, no par value; 190,000 shares authorized; 189,688 shares issued and outstanding; liquidation preference of $199,453 at February 2, 2019 actual;              shares authorized, no shares issued and outstanding pro forma and pro forma as adjusted

     75,051       

Series B preferred stock, no par value; 130,000 shares authorized; 110,000 shares issued and outstanding;              shares authorized, no shares issued and outstanding pro forma and pro forma as adjusted

     119,261       

Stockholders’ equity (deficit):

       

Common stock, $0.00001 par value; 200,000,000 shares authorized; 123,930,076 and 113,545,216 shares issued and outstanding, respectively, actual;              shares authorized pro forma and pro forma as adjusted;              shares issued and outstanding, pro forma and              shares issued and outstanding, pro forma as adjusted

     928       

Treasury stock, at cost (593,019 shares)

     (2,453     

Additional paid in capital

     606,488       

Accumulated other comprehensive loss

     (1,967     

Accumulated deficit

     (2,172,745     
  

 

 

   

 

 

    

 

 

 

Total stockholders’ equity (deficit)

     (1,569,749     
  

 

 

   

 

 

    

 

 

 

Total capitalization

   $ 391,482     $                    $                
  

 

 

   

 

 

    

 

 

 

 

(a)

Each $1.00 increase or decrease in the public offering price per share would increase or decrease, as applicable, our net proceeds, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, by $             million (assuming no exercise of the underwriters’ option to purchase additional shares). Similarly, an increase or decrease of one million shares of common stock sold in this offering by us would increase or decrease, as applicable, our net proceeds, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, by $            , based on an assumed initial public offering price of $             per share, which is the midpoint of the estimated public offering price range set forth on the cover page of this prospectus.

(b)

For a description of our indebtedness, see “Additional Information Related to Chinos Holdings—Description of Certain Indebtedness of Chinos Holdings.”

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

DILUTION

If you invest in our common stock in this offering, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the net tangible book value per share of our common stock upon the completion of this offering. Dilution results from the fact that the per share offering price of our common stock is in excess of the book value per share attributable to new investors.

Our pro forma net tangible book value as of February 2, 2019 was $            , or $             per share of common stock. Pro forma net tangible book value represents the amount of total tangible assets less total liabilities after giving effect to the Reorganization and a stock split of Chinos Holdings common stock on a              for              basis, and pro forma net tangible book value per share represents pro forma net tangible book value divided by the number of shares of common stock outstanding after giving effect to such transactions.

After giving further effect to (i) the sale of                  shares of common stock in this offering at the assumed initial public offering price of $             per share (the midpoint of the estimated public offering price range set forth on the cover page of this prospectus) and (ii) the application of the net proceeds from this offering, our pro forma as adjusted net tangible book value as of February 2, 2019 would have been $             million, or $             per share. This represents an immediate increase in pro forma as adjusted net tangible book value of $             per share to our existing investors and an immediate dilution in pro forma as adjusted net tangible book value of $             per share to new investors.

The following table illustrates this dilution on a per share of common stock basis:

 

Assumed initial public offering price per share

      $                

Pro forma net tangible book value per share as of             

     

Increase in pro forma net tangible book value per share attributable to new investors

   $                   
  

 

 

    

Pro forma as adjusted net tangible book value per share after this offering

     
     

 

 

 

Dilution in net tangible book value per share to new investors in this offering

      $    
     

 

 

 

Each $1.00 increase (decrease) in the assumed initial public offering price of $             per share (the midpoint of the estimated public offering price range set forth on the cover page of this prospectus), would increase (decrease) our as adjusted net tangible book value, after this offering by $             million, or $             per share and the dilution per share to new investors by $            , in each case assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

If the underwriters were to fully exercise their option to purchase additional shares of our common stock, our pro forma net tangible book value would be $             per share. This represents a decrease in pro forma as adjusted net tangible book value of $             per share to our existing investors and an immediate dilution of $             per share to new investors.

A one million increase (decrease) in the number of shares offered by us would increase (decrease) our as adjusted net tangible book value by approximately $                million, or $                per share, and the dilution per share to new investors by approximately $                , in each case assuming the initial public offering price of $             per share, which is the midpoint of the estimated offering price range set forth on the cover page of this prospectus remains the same, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

The following table summarizes, on an as adjusted basis as of February 2, 2019, after giving effect to this offering, the total number of shares of common stock purchased from us, the total cash consideration paid to

 

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us, or to be paid, and the average price per share paid, or to be paid, by new investors purchasing shares in this offering, at an assumed initial public offering price of $             per share, which is the midpoint of the estimated public offering price range set forth on the cover page of this prospectus, before deducting the estimated underwriting discounts and commissions:

 

    

Shares Purchased

   

Total Consideration

   

Average Price

Per Share

 
    

Number

    

Percent

   

Amount

    

Percent

 

Existing stockholders

                                $                             $                

New investors

            
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total

        100.0   $          100.0   $    
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

If the underwriters were to fully exercise their option to purchase                  additional shares of our common stock, the percentage of shares of our common stock held by existing investors would be     %, and the percentage of shares of our common stock held by new investors would be     %.

The foregoing tables and calculations exclude              shares of our common stock, reserved for future issuance under our 2019 Equity Incentive Plan as of the date hereof, which will be effective upon the completion of this offering. To the extent equity awards are granted and exercised, there will be further dilution to new investors.

The above discussion and tables are based on the number of shares outstanding at                 , after giving effect to the Reorganization. In addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities could result in further dilution to our stockholders.

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

ADDITIONAL INFORMATION RELATED TO CHINOS HOLDINGS

The information appearing in this section includes additional information regarding the J.Crew business that will be spun off from Chinos Holdings in the Separation. Chinos Holdings, Inc., the issuer of common stock in this offering, will have no interest in the J.Crew business after giving effect to the Reorganization. Although investors in this offering will be purchasing shares of Chinos Holdings, they will be investing only in the Madewell business.

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA OF CHINOS HOLDINGS

The following tables set forth selected historical consolidated financial data of Chinos Holdings and its consolidated subsidiaries. They include the results of operations, assets and liabilities associated with both the Madewell business and J.Crew business. The J.Crew business will be spun off from Chinos Holdings in the Separation. An investment in us in this offering is an investment in the Madewell business. We will not own, operate or have any interest in the J.Crew business following the Reorganization, however, we will receive certain services from and make related payments to the J.Crew business under the Transition Services Agreement as further described in “Other Information Related to this Offering—Certain Relationships and Related Party Transactions—Relationship with J.Crew—Transition Services Agreement” contained elsewhere in this prospectus. You should read the information set forth below in conjunction with “Use of Proceeds,” “Capitalization,” “Additional Information Related to Chinos Holdings—Management’s Discussion and Analysis of Financial Condition and Results of Operations of Chinos Holdings” and the audited historical consolidated financial statements of Chinos Holdings and notes thereto included elsewhere in this prospectus.

The selected historical consolidated financial data for fiscal 2018, fiscal 2017 and fiscal 2016 and as of February 2, 2019 and February 3, 2018 is based on the historical consolidated financial statements of Chinos Holdings included elsewhere in this prospectus. The selected historical consolidated financial data for fiscal 2015 and fiscal 2014, and as of January 28, 2017, January 30, 2016 and January 31, 2015 is based on the unaudited pro forma consolidated financial statements of Chinos Holdings which are not included in this prospectus. Once we have completed the Reorganization, results of operations of the J.Crew business will be reported as discontinued operations for accounting purposes and our continuing operations will consist solely of the Madewell business. The historical results of operations of the J.Crew business reported as discontinued operations may not be comparable to the adjustments to our unaudited pro forma consolidated financial data for the Separation of the J.Crew business. See “Additional Information Related to the Madewell Business—Supplemental Selected Historical Combined Financial Data of the Madewell Business” for additional information regarding the operations and assets and liabilities of the Madewell business. Accordingly, the historical results of Chinos Holdings presented below will not be indicative of the results to be expected for any future period.

 

    

For the Year Ended

 
(Dollars in thousands, unless otherwise indicated)   

February 2,
2019

   

February 3,
2018(a)

   

January 28,
2017

   

January 30,
2016(c)

   

January 31,
2015(c)

 
                       (Unaudited)     (Unaudited)  

Income Statement Data:

          

Total revenues

   $ 2,483,994     $ 2,373,695     $ 2,431,595     $ 2,505,827     $ 2,579,695  

Cost of goods sold, including buying and occupancy costs

     1,648,330       1,476,064       1,550,305       1,610,256       1,608,777  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     835,664       897,631       881,290       895,571       970,918  

Selling, general and administrative expenses

     814,337       851,658       824,290       834,137       845,953  

Impairment losses

     10,765       141,187       7,752       1,381,642       709,985  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     10,562       (95,214     49,248       (1,320,208     (585,020

Interest expense, net

     78,738       97,866       125,530       111,334       114,786  

Loss on refinancings

     —         11,749       435       —         58,960  

Benefit for income taxes

     (398     (133,120     (6,308     (163,249     (76,126
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (67,778   $ (71,709   $ (70,409   $ (1,268,293   $ (682,640
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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For the Year Ended

 
(Dollars in thousands, unless otherwise indicated)   

February 2,
2019

   

February 3,
2018(a)

   

January 28,
2017

   

January 30,
2016(c)

   

January 31,
2015(c)

 
                       (Unaudited)     (Unaudited)  

Operating Data:

          

Revenues:

          

J.Crew

   $ 1,779,547     $ 1,848,034     $ 2,018,542     $ 2,146,710     $ 2,295,109  

Madewell

     529,148       419,776       341,468       300,982       245,340  

Other

     175,299       105,885       71,585       58,135       39,246  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

   $ 2,483,994     $ 2,373,695     $ 2,431,595     $ 2,505,827     $ 2,579,695  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Increase (decrease) in comparable company sales(b)

     6.0     (6.1 )%      (6.1 )%      (8.2 )%      (0.7 )% 

Stores open at end of period:

          

J.Crew

     377       411       460       446       419  

Madewell

     129       121       113       103       85  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stores open at end of period

     506       532       573       549       504  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Capital expenditures:

          

J.Crew new stores and store improvements

   $ 5,802     $ 7,842     $ 28,518     $ 44,622     $ 54,135  

Madewell new stores and store improvements

     10,096       7,828       10,860       15,213       16,502  

Other

     36,838       24,008       40,762       43,822       57,237  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total capital expenditures

   $ 52,736     $ 39,678     $ 80,140     $ 103,657     $ 127,874  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Depreciation of property and equipment

   $ 88,028     $ 101,288     $ 109,503     $ 103,966     $ 93,458  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amortization of intangible assets

   $ 7,236     $ 9,086     $ 10,540     $ 15,559     $ 15,944  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a)

Consists of 53 weeks.

(b)

Calculated on a 52-week basis.

(c)

Fiscal 2015 and fiscal 2014 amounts do not reflect the adoption of new revenue recognition guidance.

 

    

As of

 
(Dollars in thousands, unless otherwise
indicated)
  

February 2,
2019

   

February 3,
2018

   

January 28,
2017

    

January 30,
2016(a)

    

January 31,
2015(a)

 
                 (Unaudited)      (Unaudited)      (Unaudited)  

Balance Sheet Data:

            

Cash and cash equivalents

   $ 28,055     $ 109,468     $ 132,259      $ 87,816      $ 111,791  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total assets(b)

   $ 1,223,937     $ 1,212,622     $ 1,445,501      $ 1,528,236      $ 2,929,753  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total debt, net

   $ 1,866,227     $ 1,933,065     $ 2,049,411      $ 2,011,589      $ 2,021,086  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total stockholders’ equity (deficit)

   $ (1,569,749   $ (1,481,445   $ (1,307,354)      $ (1,238,268)      $ 34,301  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

 

(a)

Fiscal 2015 and fiscal 2014 amounts do not reflect the adoption of new revenue recognition guidance.

(b)

Includes restricted cash of $13.7 million at February 2, 2019.

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL DATA OF CHINOS HOLDINGS

The following unaudited pro forma consolidated financial data presents the historical consolidated statements of operations of Chinos Holdings for fiscal 2018 and the consolidated balance sheet of Chinos Holdings as of February 2, 2019 after giving effect to the transactions and adjustments as described in the accompanying notes. In management’s opinion, the unaudited pro forma consolidated financial statements reflect certain adjustments that are necessary to present fairly our unaudited pro forma consolidated results of operations and our unaudited pro forma consolidated balance sheet as of and for the periods indicated. The pro forma adjustments give effect to events that are (i) directly attributable to the transactions described below, (ii) factually supportable, and, with respect to the statement of operations, (iii) expected to have a continuing impact on us. The pro forma adjustments are based on assumptions that management believes are reasonable given the best information currently available.

The following unaudited pro forma consolidated financial statements should be read in conjunction with “Additional Information Related to the Madewell Business—Supplemental Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Madewell Business,” “Additional Information Related to the Madewell Business—Supplemental Selected Historical Combined Financial Data of the Madewell Business,” “Additional Information Related to Chinos Holdings—Management’s Discussion and Analysis of Financial Condition and Results of Operations of Chinos Holdings,” “Additional Information Related to Chinos Holdings—Selected Historical Consolidated Financial Data of Chinos Holdings,” the historical consolidated financial statements of Chinos Holdings and related notes thereto appearing elsewhere in this prospectus and “The Reorganization.”

The unaudited pro forma consolidated financial statements are for illustrative and informational purposes only and are not intended to represent what our results of operations or financial position would have been had the Madewell business been operated as an independent, publicly traded company during the periods presented or if the transactions described below had actually occurred as of the dates indicated. The unaudited pro forma consolidated financial statements also should not be considered indicative of our future results of operations or financial position as an independent, publicly traded company after the completion of this offering.

This unaudited pro forma consolidated financial data give effect to anticipated transactions and adjustments that are relevant to an understanding of the business being offered and will have a material impact on the comparability of the results of operations of Chinos Holdings. They are described below and are as follows: (i) “—The Separation,” (ii) “—The Transition Services Agreement” and (iii) “—This Offering.”

The Separation

As described in “The Reorganization” included elsewhere in this prospectus, Chinos Holdings is pursuing the Separation, pursuant to which it will effect a series of transactions to spinoff the J.Crew business to its stockholders, after which the J.Crew business will cease to be a part of Chinos Holdings. We refer to this series of transactions as the “Separation.” After the Separation, certain pre-Separation indebtedness of Chinos Holdings will be an obligation of the J.Crew business and will not be an obligation of Chinos Holdings on a consolidated basis. Once these transactions have occurred, the J.Crew business will be owned and operated separately from us. After completion of this offering, the Madewell business will represent our only assets, liabilities, and operations. Although Chinos Holdings, Inc. is the legal issuer of the shares offered in this offering, an investment in us in this offering is an investment in the Madewell business. In addition, Chinos Holdings will not be an obligor or guarantor of, or have any assets pledged as collateral for, any of its pre-Reorganization indebtedness after the Reorganization. Following the completion of this offering, we expect to report the J.Crew business operations as discontinued operations in accordance with ASC Topic 205 Presentation of Financial Statements beginning with our first financial statements filed after the effectiveness of the registration statement of which this prospectus forms a part. All pro forma adjustments to our historical financial statements that relate to the Separation are described as “Separation Adjustments” and they are included under the caption “—The Separation.”

 

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The Transition Services Agreement

In connection with the Separation, concurrently with this offering, we expect to enter into the Transition Services Agreement and other related agreements, pursuant to which entities operating the J.Crew business will continue to provide us with certain administrative capabilities for a specified period of time following the Reorganization. See “Other Information Related to this Offering—Certain Relationships and Related Party Transactions—Relationship with J.Crew.”

This Offering

Pro forma adjustments in connection with this offering to reflect (i) our receipt of the estimated net proceeds from the sale of common stock by us in the offering at an assumed initial public offering price of $             per share (the midpoint of the range appearing on the cover page of this prospectus), after deducting the assumed underwriting discount and commissions and estimated fees and expenses payable by us; (ii) the incurrence of new indebtedness in connection with the Reorganization; (iii) the application of the net proceeds of this offering together with the proceeds from the incurrence of new indebtedness to repay certain pre-Reorganization indebtedness of Chinos Holdings, as described in “Use of Proceeds;” and (iv) the exchange of shares of Chinos Holdings common stock for certain of its pre-Reorganization indebtedness. After the Reorganization, we will not be an obligor or guarantor of, or have any assets pledged as collateral for, any of Chinos Holdings’ pre-Reorganization indebtedness.

We have not adjusted the accompanying unaudited pro forma combined statements of operations for new costs relating to our public reporting and compliance obligations as an independent, publicly traded company as they are projected amounts based on estimates and are not factually supportable. We anticipate that we will incur between approximately $             and $             in new costs relating to our public reporting and compliance obligations on an annual basis upon completion of this offering.

The unaudited pro forma combined statements of operations exclude certain non-recurring costs that we have incurred or expect to incur related to the Reorganization and this offering. We expect these costs to be in a range from $             million to $             million.

Unaudited Pro Forma Financial Data

In accordance with Article 11 of Regulation S-X we have provided the unaudited pro forma consolidated statements of operations of Chinos Holdings for fiscal 2018, presented on a pro forma basis to give effect to the Separation, the Transition Services Agreement and the offering as if they had occurred on February 4, 2018 and the unaudited pro forma consolidated balance sheet of Chinos Holdings as of February 2, 2019 as if these transactions had occurred on February 2, 2019.

 

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UNAUDITED PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS

YEAR ENDED FEBRUARY 2, 2019

 

   

Actual

   

The Separation

   

The Transition Services
Agreement

   

This Offering

 
   

Separation
Adjustments

   

Pro Forma

   

Transition
Services
Agreement
Adjustments

   

Pro Forma

   

Offering
Adjustments

   

Pro Forma

 
(Dollars in thousands)                                          

Revenues

  $ 2,483,994     $                   $                   $                   $                   $                   $                

Cost of goods sold, including buying and occupancy costs

    1,648,330              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

  $ 835,664     $       $       $       $       $       $    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selling, general and administrative expenses

    814,337              

Loss before income taxes

    (68,176            

Benefit for income taxes

    (398            
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (67,778   $       $       $       $       $       $    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) per share

             

Basic

  $ (0.86   $       $       $       $       $       $    

Diluted

  $ (0.86   $       $       $       $       $       $    

Weighted average common shares outstanding (in thousands)

             

Basic

    113,057              

Diluted

    113,057              

See accompanying Notes to Unaudited Pro Forma Consolidated Financial Statements.

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET

AS OF FEBRUARY 2, 2019

 

   

Actual

   

The Separation

   

The Transition Services
Agreement

   

This Offering

 
   

Separation
Adjustments

   

Pro Forma

   

Transition
Services
Agreement
Adjustments

   

Pro Forma

   

Offering
Adjustments

   

Pro Forma

 
(Dollars in thousands)                                          

Current Assets:

             

Cash and cash equivalents

  $ 28,055     $                   $                   $                   $                   $                   $                

Accounts receivable, net

    40,342              

Merchandise inventories, net

    390,470              

Prepaid expenses and other current assets

    84,942              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

  $ 564,856     $       $       $       $       $       $    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Property and equipment, net

    243,620              

Intangible assets, net

    301,397              

Goodwill

    107,900              

Other assets

    6,164              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 1,223,937     $       $       $       $       $       $    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current Liabilities:

             

Accounts payable

    259,705              

Other current liabilities

    245,142              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current liabilities

  $ 680,217     $       $       $       $       $       $    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Lease-related deferred credits, net

    106,037              

Deferred income taxes, net

    18,943              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

  $ 2,599,374     $       $       $       $       $       $    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Stockholders’ equity (deficit):

             

Common stock $0.00001 par value; 200,000,000 shares authorized; 123,930,076 and 118,503,554 shares issued; 113,545,216 and 112,740,100 shares outstanding

    928              

Retained earnings (accumulated deficit)

    (2,172,745            
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stockholders’ equity (deficit)

  $ (1,569,749   $       $       $       $       $       $    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and stockholders’ equity (deficit)

  $ 1,223,937     $       $       $       $       $       $    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to Unaudited Pro Forma Consolidated Financial Statements.

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS

We will provide notes to our unaudited pro forma consolidated financial statements in subsequent amendments to the registration statement, of which this prospectus is a part, and prior to the completion of this offering.

 

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FOIA Confidential Treatment Requested by Chinos Holdings, Inc. Pursuant to 17 CFR 200.83

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF CHINOS HOLDINGS

The following is a discussion and analysis of the financial condition and results of operations of Chinos Holdings as of, and for, the periods presented. Such information includes the J.Crew business that will be spun off pursuant to the Separation and does not give effect to the Reorganization and may not be comparable to the financial condition and results of operations of Chinos Holdings after the completion of the Reorganization. See “—Basis of Presentation.” You should read the following discussion together with “Additional Information Related to Chinos Holdings—Selected Historical Consolidated Financial Data of Chinos Holdings” and the historical consolidated financial statements of Chinos Holdings and related notes included elsewhere in this prospectus. This discussion and analysis contains forward-looking statements, including statements regarding industry outlook, Chinos Holdings’ expectations for the future of its business, and Chinos Holdings’ liquidity and capital resources as well as other non-historical statements. These statements are based on current expectations and are subject to numerous risks and uncertainties, including but not limited to the risks and uncertainties described in “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.” Chinos Holdings’ actual results may differ materially from those contained in or implied by these forward-looking statements.

The businesses of Chinos Holdings described in this section represent the combined financial condition and results of operations of the J.Crew business and the Madewell business. The J.Crew business will not be owned by investors in this offering following the Reorganization. An investment in us in this offering is an investment in the Madewell business. In addition, the following includes discussion and analysis of Chinos Holdings’ historical indebtedness. We will not be an obligor or a guarantor of any of Chinos Holdings’ pre-Reorganization indebtedness after the Reorganization. Chinos Holdings’ presentation of certain financial information, such as revenues, is different from, and may not be comparable to, the presentation of corresponding financial information for the Madewell business. For a discussion and analysis of the financial information relating solely to the Madewell business, please see “Additional Information Related to the Madewell Business—Supplemental Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Madewell Business.”

Chinos Holdings’ fiscal year ends on the Saturday closest to January 31, typically resulting in a 52-week year, but occasionally includes an additional week, resulting in a 53-week year. All references to fiscal 2018 reflect the results of the 52-week period ended February 2, 2019; all references to fiscal 2017 reflect the results of the 53-week period ended February 3, 2018; and all references to fiscal 2016 reflect the results of the 52-week period ended January 28, 2017. In addition, all references to fiscal 2019 reflect the 52-week period ending February 1, 2020.

As used in this section only, unless the context requires otherwise, “Chinos Holdings” the “Company,” “we,” “us” or “our” refer to Chinos Holdings, Inc. and its consolidated subsidiaries, “Madewell” refers to the Madewell business and “J.Crew” refers to the J.Crew business, in each case, prior to giving effect to the Reorganization.

Business Summary

As of February 2, 2019, we operated 203 J.Crew retail stores, 174 J.Crew factory stores (including 42 J.Crew Mercantile stores) and 129 Madewell stores throughout the United States, Canada, the United Kingdom and Hong Kong; compared to 235 J.Crew retail stores, 176 J.Crew factory stores (including 42 J.Crew Mercantile stores) and 121 Madewell stores as of February 3, 2018.

How We Assess the Performance of Our Business

In assessing the performance of our business, we consider a variety of performance and financial measures. A key measure used in evaluating our business is comparable company sales. We also consider gross profit and selling, general and administrative expenses in assessing the performance of our business.

 

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Net Sales

Net sales reflect our revenues from the sale of our merchandise less returns and discounts. We aggregate our merchandise into four sales categories: (i) women’s apparel, (ii) men’s apparel, (iii) children’s apparel, and (iv) accessories, which include shoes, socks, jewelry, handbags, belts and hair accessories. The approximate percentage of our sales by these four categories is as follows:

 

    

Fiscal

2018

   

Fiscal

2017

   

Fiscal

2016

 

Apparel

      

Women’s

     57     55     54

Men’s

     21       23       24  

Children’s

     7       7       7  

Accessories

     15       15       15  
  

 

 

   

 

 

   

 

 

 
     100     100     100
  

 

 

   

 

 

   

 

 

 

Comparable Company Sales

Comparable company sales reflect: (i) net sales at stores that have been open for at least 12 months, (ii) e-commerce net sales, and (iii) shipping and handling fees, all of which are included in DTC revenues. Comparable company sales exclude net sales from: (i) new stores that have not been open for 12 months, (ii) the 53rd week, if applicable, (iii) stores that experience a square footage change of at least 15 percent, (iv) stores that have been temporarily closed for at least 30 consecutive days, (v) permanently closed stores, (vi) temporary “pop up” stores and (vii) revenue from wholesale customers. Due to the 53rd week in fiscal 2017, when calculating comparable company sales for fiscal 2018, we have realigned the weeks of last year to be consistent with the current year retail calendar.

Measuring the change in year-over-year comparable company sales allows us to evaluate the performance of our business. Various factors affect comparable company sales, including:

 

   

consumer preferences, fashion trends, buying trends and overall economic trends,

 

   

competition,

 

   

changes in our merchandise mix,

 

   

pricing,

 

   

the timing of our releases of new merchandise and promotional events,

 

   

the level of customer service that we provide,

 

   

our ability to source and distribute products efficiently and

 

   

the number of stores we open, close (including on a temporary basis for renovations) and expand in any period.

Cyclicality and Seasonality

Our industry is cyclical and our revenues are affected by general economic conditions. Purchases of apparel and accessories are sensitive to a number of factors that influence the levels of consumer spending, including economic conditions and the level of disposable consumer income, consumer debt, interest rates, foreign currency exchange rates and consumer confidence.

 

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Our business is seasonal and as a result, our revenues fluctuate from quarter to quarter. We have four distinct selling seasons that align with our four fiscal quarters. Revenues are usually higher in our fourth fiscal quarter, particularly in December when customers make holiday purchases. In fiscal 2018, we realized approximately 30% of our revenues in the fourth fiscal quarter.

Gross Profit

Gross profit is determined by subtracting our cost of goods sold from our revenues. Cost of goods sold includes the direct cost of purchased merchandise, freight, design, buying and production costs, occupancy costs related to store operations (such as rent and utilities) and all shipping costs associated with our e-commerce business. Cost of goods sold varies directly with revenues, and therefore, is usually higher in our fourth fiscal quarter. Cost of goods sold also changes as we expand or contract our store base, which results in higher or lower store occupancy costs. The primary drivers of the costs of individual goods are the costs of raw materials and labor in the countries where we source our merchandise. Gross margin measures gross profit as a percentage of our revenues.

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

At the end of fiscal 2018, we owned substantial excess merchandise inventories. As a result, we recorded a charge of $39.3 million for expected losses on the disposition of those inventories.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include all operating expenses not included in cost of goods sold, primarily administrative payroll, store expenses other than occupancy costs, depreciation and amortization, certain warehousing expenses and credit card fees. These expenses do not necessarily vary proportionally with net sales.

Results of Operations

The following table presents our operating results as a percentage of revenues as well as selected store data:

 

    

Fiscal

2018

   

Fiscal

2017

   

Fiscal

2016

 

Revenues

     100.0     100.0     100.0

Cost of goods sold, including buying and occupancy costs(a)

     66.4       62.2       63.8  
  

 

 

   

 

 

   

 

 

 

Gross profit(a)

     33.6       37.8       36.2  

Selling, general and administrative expenses(a)

     32.8       35.9       33.9  

Impairment losses

     0.4       5.9       0.3  
  

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     0.4       (4.0     2.0  

Interest expense, net

     3.2       4.1       5.2  

Loss on refinancing

     —         0.5       —    
  

 

 

   

 

 

   

 

 

 

Loss before income taxes

     (2.7     (8.6     (3.2

Benefit for income taxes

     —         (5.6     (0.3
  

 

 

   

 

 

   

 

 

 

Net loss

     (2.7 )%      (3.0 )%      (2.9 )% 
  

 

 

   

 

 

   

 

 

 

 

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Fiscal

2018

   

Fiscal

2017

   

Fiscal

2016

 

Selected company data:

      

J.Crew:

      

Number of stores open at end of period

     377       411       460  

Increase (decrease) in J.Crew comparable sales(b)

     1.5     (9.6 )%      (7.8 )% 

Madewell:

      

Number of stores open at end of period

     129       121       113  

Increase in Madewell comparable sales(b)

     25.0     14.4     6.5

 

(a)

We exclude a portion of our distribution network costs from cost of goods sold and include them in selling, general and administrative expenses. Our gross profit therefore may not be directly comparable to that of some of our competitors.

(b)

Calculated on a 52-week basis.

Results of Operations—Fiscal 2018 compared to Fiscal 2017

 

    

Fiscal 2018

   

Fiscal 2017(a)

   

Variance

Increase/(Decrease)

 
(Dollars in millions)   

Amount

   

Percent
of
Revenues

   

Amount

   

Percent
of
Revenues

   

Dollars

   

Percentage

 

Revenues

   $ 2,484.0       100.0   $ 2,373.7       100.0   $ 110.3       4.6

Gross profit

     835.7       33.6       897.6       37.8       (61.9     (6.9

Selling, general and administrative expenses

     814.3       32.8       851.7       35.9       (37.4     (4.4

Impairment losses

     10.8       0.4       141.2       5.9       (130.4     (92.4

Income (loss) from operations

     10.6       0.4       (95.2     (4.0     105.8       NM  

Interest expense, net

     78.7       3.2       97.9       4.1       (19.2     (19.5

Loss on refinancing

     —         —         11.7       0.5       (11.7     (100.0

Benefit for income taxes

     (0.4     —         (133.1     (5.6     132.7       99.7  

Net loss

   $ (67.8     (2.7 )%    $ (71.7     (3.0 )%    $ 3.9       5.5

 

(a)

Consists of 53 weeks.

Revenues

Total revenues increased $110.3 million, or 4.6%, to $2,484.0 million in fiscal 2018 from $2,373.7 million in fiscal 2017, driven primarily by an increase in sales of women’s apparel, specifically pants, sweaters and knits. Revenues generated in the 53rd week of fiscal 2017 were $28.6 million. Comparable company sales increased 6.0% following a decrease of 6.1% in fiscal 2017.

DTC revenues increased $45.1 million, or 2.0%, to $2,346.4 million in fiscal 2018 from $2,301.3 million in fiscal 2017, driven by increasing performance at Madewell offset by decreasing performance at J.Crew.

 

   

Madewell DTC revenues increased $111.1 million, or 26.3%, to $533.9 million in fiscal 2018 from $422.8 million in fiscal 2017. Madewell comparable sales increased 25.0% following an increase of 14.4% in fiscal 2017.

 

   

J.Crew DTC revenues decreased $66.0 million, or 3.5%, to $1,812.5 million in fiscal 2018 from $1,878.5 million in fiscal 2017. J.Crew comparable sales increased 1.5% following a decrease of 9.6% in fiscal 2017.

Wholesale revenues increased $64.5 million to $126.7 million in fiscal 2018 from $62.2 million in fiscal 2017, driven primarily by an increase of sales to Nordstrom.

 

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Gross Profit

Gross profit decreased $61.9 million to $835.7 million in fiscal 2018 from $897.6 million in fiscal 2017. This decrease resulted from the following factors:

 

(Dollars in millions)    Increase/
(decrease)
 

Increase in revenues

   $ 57.0  

Decrease in merchandise margin

     (121.1

Decrease in buying and occupancy costs

     2.2  
  

 

 

 

Decrease in gross profit

   $ (61.9
  

 

 

 

Gross margin decreased to 33.6% in fiscal 2018 from 37.8% in fiscal 2017. The decrease in gross margin was driven by: (i) a 490 basis point deterioration in merchandise margin primarily due to higher shipping and handling driven by e-commerce growth, a higher level of promotional activity and increased penetration of our wholesale business, offset by (ii) a 70 basis point decrease in buying and occupancy costs as a percentage of revenues.

At the end of fiscal 2018, we owned substantial excess merchandise inventories. As a result, we recorded a charge of $39.3 million for expected losses on the disposition of those inventories.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased $37.4 million, or 4.4%, to $814.3 million in fiscal 2018 from $851.7 million in fiscal 2017. This decrease primarily resulted from the following:

 

(Dollars in millions)    Increase/
(decrease)
 

Decrease in transformation costs

   $ (43.6

Corporate occupancy action

     (24.6

Decrease in depreciation

     (13.3

Increase in operating and corporate expenses

     8.6  

Increase in marketing costs

     35.5  
  

 

 

 

Total decrease in selling, general and administrative expenses

   $ (37.4
  

 

 

 

As a percentage of revenues, selling, general and administrative expenses decreased to 32.8% in fiscal 2018 from 35.9% in fiscal 2017.

Impairment Losses

Impairment losses were $10.8 million in fiscal 2018 compared to $141.2 million in fiscal 2017. The impairment losses were the result of the write-down of the following assets:

 

(Dollars in millions)    Fiscal 2018      Fiscal 2017  

Intangible asset related to the J.Crew trade name

   $ —        $ 129.8  

Long-lived assets

     10.8        11.4  
  

 

 

    

 

 

 

Impairment losses

   $ 10.8      $ 141.2  
  

 

 

    

 

 

 

 

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Interest Expense, Net

Interest expense, net of interest income, decreased $19.2 million to $78.7 million in fiscal 2018 from $97.9 million in fiscal 2017. A summary of interest expense is as follows:

 

(Dollars in millions)    Fiscal 2018      Fiscal 2017  

Term Loan Facility

   $ 78.2      $ 66.1  

Notes

     45.1        24.7  

Amortization of deferred financing costs and debt discount

     3.7        5.2  

ABL Facility

     3.3        0.3  

Realized hedging losses

     2.4        10.7  

PIK Notes

     0.1        19.6  

Interest expense reductions under TDR

     (55.4      (31.4

Other, net of interest income

     1.3        2.7  
  

 

 

    

 

 

 

Interest expense, net

   $ 78.7      $ 97.9  
  

 

 

    

 

 

 

Loss on Refinancing

We accounted for the Exchange Offer (as defined below) in accordance with ASC 470 – Debt, which resulted in a portion of the exchange to be considered a troubled debt restructuring (“TDR”). In fiscal 2017, we recognized a related loss of $11.7 million.

Benefit for Income Taxes

The effective tax rate for fiscal 2018 was 1%. Items driving differences between the U.S. federal statutory rates of 21% and the effective rate include (i) increase in the valuation allowance recorded against deferred taxes, (ii) state and local income taxes and (iii) lower rates in certain foreign jurisdictions.    

The effective tax rate for fiscal 2017 was 65%. Items driving differences between the blended U.S. federal statutory rates of 33.7% and the effective rate include (i) the accounting for a troubled debt restructuring, (ii) the change in tax rates from Tax Reform, (iii) state and local income taxes, (iv) lower rates in certain foreign jurisdictions and (v) changes in our valuation allowances, including the reversal of the valuation allowance recorded against deferred taxes at the federal level, offset by increases in the valuation allowance recorded against deferred taxes in certain foreign jurisdictions.

Net Loss

Net loss decreased $3.9 million to $67.8 million in fiscal 2018 from $71.7 million in fiscal 2017. This decrease was due to: (i) a decrease in impairment losses of $130.4 million, (ii) a decrease in selling, general and administrative expenses of $37.4 million, (iii) a decrease in interest expense of $19.2 million and (iv) a decrease in loss on refinancing of $11.7 million, offset by (v) a decrease in the benefit for income taxes of $132.7 million and (vi) a decrease in gross profit of $61.9 million.

 

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Results of Operations—Fiscal 2017 compared to Fiscal 2016

 

    

Fiscal 2017(a)

   

Fiscal 2016

   

Variance

Increase/(Decrease)

 
(Dollars in millions)    Amount     Percent
of
Revenues
    Amount     Percent
of
Revenues
    Dollars     Percentage  

Revenues

   $ 2,373.7       100.0   $ 2,431.6       100.0   $ (57.9     (2.4 )% 

Gross profit

     897.6       37.8       881.3       36.2       16.3       1.9  

Selling, general and administrative expenses

     851.7       35.9       824.3       33.9       27.4       3.3  

Impairment losses

     141.2       5.9       7.8       0.3       133.4       NM  

Income (loss) from operations

     (95.2     (4.0     49.2       2.0       (144.4     NM  

Interest expense, net

     97.9       4.1       125.5       5.2       (27.6     (22.0

Loss on refinancings

     11.7       0.5       0.4       —         11.3       NM  

Benefit for income taxes

     (133.1     (5.6     (6.3     (0.3     (126.8     NM  

Net loss

   $ (71.7     (3.0 )%    $ (70.4     (2.9 )%    $ (1.3     (1.8 )% 

 

(a)

Consists of 53 weeks.

Revenues

Total revenues decreased $57.9 million, or 2.4%, to $2,373.7 million in fiscal 2017 from $2,431.6 million in fiscal 2016, driven primarily by a decrease in sales of men’s apparel, specifically shirts, suiting and pants. Revenues generated in the 53rd week of fiscal 2017 were $28.6 million. Comparable company sales decreased 6.1% in fiscal 2017 following a decrease of 6.1% in fiscal 2016.

DTC revenues decreased $90.2 million, or 3.8%, to $2,301.3 million in fiscal 2017 from $2,391.5 million in fiscal 2016, driven by performance at decreasing J.Crew offset by increasing performance at Madewell.

 

   

J.Crew DTC revenues decreased $169.4 million, or 8.3%, to $1,878.5 million in fiscal 2017 from $2,047.9 million in fiscal 2016. J.Crew comparable sales decreased 9.6% in fiscal 2017 following a decrease of 7.8% in fiscal 2016.

 

   

Madewell DTC revenues increased $79.2 million, or 23.0%, to $422.8 million in fiscal 2017 from $343.6 million in fiscal 2016. Madewell comparable sales increased 14.4% in fiscal 2017 following an increase of 6.5% in fiscal 2016.

Wholesale revenues increased $33.5 million to $62.2 million in fiscal 2017 from $28.7 million in fiscal 2016, driven primarily by an increase of sales to Nordstrom.

Gross Profit

Gross profit increased $16.3 million to $897.6 million in fiscal 2017 from $881.3 million in fiscal 2016. This increase resulted from the following factors:

 

(Dollars in millions)    Increase/
(decrease)
 

Decrease in revenues

   $ (29.0

Increase in merchandise margin

     36.9  

Decrease in buying and occupancy costs

     8.4  
  

 

 

 

Increase in gross profit

   $ 16.3  
  

 

 

 

 

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Gross margin increased to 37.8% in fiscal 2017 from 36.2% in fiscal 2016. The increase in gross margin was driven by a 160 basis point expansion in merchandise margin due to favorable product costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $27.4 million, or 3.3%, to $851.7 million in fiscal 2017 from $824.3 million in fiscal 2016. This increase primarily resulted from the following:

 

(Dollars in millions)    Increase/
(decrease)
 

Transformation costs

   $ 50.7  

Charges related to workforce reductions

     11.9  

Corporate occupancy actions last year

     10.6  

Decrease in marketing costs

     (4.6

Decrease in depreciation

     (8.2

Decrease in operating and corporate expenses

     (9.8

Decrease in consulting fees

     (9.9

Decrease in payroll and related expenses

     (13.3
  

 

 

 

Total increase in selling, general and administrative expenses

   $ 27.4  
  

 

 

 

As a percentage of revenues, selling, general and administrative expenses increased to 35.9% in fiscal 2017 from 33.9% in fiscal 2016.

Impairment Losses

Impairment losses were $141.2 million in fiscal 2017 compared to $7.8 million in fiscal 2016. The impairment losses were the result of the write-down of the following assets:

 

(Dollars in millions)    Fiscal 2017      Fiscal 2016  

Intangible asset related to the J.Crew trade name

   $ 129.8      $   —    

Long-lived assets

     11.4        7.8  
  

 

 

    

 

 

 

Impairment losses

   $ 141.2      $ 7.8  
  

 

 

    

 

 

 

Interest Expense, Net

Interest expense, net of interest income, decreased $27.6 million to $97.9 million in fiscal 2017 from $125.5 million in fiscal 2016. A summary of interest expense is as follows:

 

(Dollars in millions)    Fiscal 2017      Fiscal 2016  

Term Loan Facility

   $ 66.1      $ 62.0  

Notes

     24.7        —    

PIK Notes

     19.6        44.3  

Realized hedging losses

     10.7        10.5  

Amortization of deferred financing costs and debt discount

     5.2        6.9  

Interest expense reductions under TDR

     (31.4      —    

Other, net of interest income

     3.0        1.8  
  

 

 

    

 

 

 

Interest expense, net

   $ 97.9      $ 125.5  
  

 

 

    

 

 

 

Loss on Refinancings

We accounted for the Exchange Offer (as defined below) in accordance with ASC 470-Debt, which resulted in a portion of the exchange to be considered a TDR. In fiscal 2017, we recognized a related loss of $11.7 million.

 

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Benefit for Income Taxes

In December 2017, significant changes were made to the federal tax law in the United States. Among its many provisions, the Tax Reform reduced the corporate federal tax rate from 35% to 21%. As a result of the new rate, we remeasured our deferred tax assets and liabilities at the rate we expect to be in effect when the deferred taxes will reverse.    

The benefit for income taxes for fiscal 2017 was $133.1 million, which included (i) a deferred tax benefit of $50.6 million related to the intangible asset for the J.Crew trade name, which was written down by $129.8 million in fiscal 2017 and (ii) the remeasurement of deferred taxes of $18.5 million pursuant to Tax Reform.

The effective tax rate for fiscal 2017 was 65%. Items driving differences between the blended U.S. federal statutory rates of 33.7% and the effective rate include (i) the accounting for a troubled debt restructuring, (ii) the change in tax rates from Tax Reform, (iii) state and local income taxes, (iv) lower rates in certain foreign jurisdictions and (v) changes in our valuation allowances, including the reversal of the valuation allowance recorded against deferred taxes at the federal level, offset by increases in the valuation allowance recorded against deferred taxes in certain foreign jurisdictions.

Although Tax Reform significantly reduced the federal tax rate, it substantially reduced our ability to deduct interest expense beginning in fiscal 2018. The inability to use our interest deductions either in a current year, or carried forward to future years, has increased our projections of future taxable income.

The effective tax rate for fiscal 2016 was 8%. Items driving differences between the U.S. federal statutory rate of 35% and the effective rate include (i) the recognition of certain valuation allowances, (ii) lower rates in certain foreign jurisdictions and (iii) reserves for uncertain tax positions.

Net Loss

Net loss increased $1.3 million to $71.7 million in fiscal 2017 from $70.4 million in fiscal 2016. This increase was due to: (i) higher impairment losses of $133.4 million, (ii) an increase in selling, general and administrative expenses of $27.4 million and (iii) an increase in loss on refinancing of $11.3 million, offset by (iv) an increase in the benefit for income taxes of $126.8 million, (v) a decrease in interest expense of $27.6 million and (vi) an increase in gross profit of $16.3 million.

Liquidity and Capital Resources

Our primary sources of liquidity are our current balances of cash and cash equivalents and borrowings available under the ABL Facility. Our primary cash needs are (i) meeting debt service requirements, (ii) capital expenditures in connection with making information technology enhancements, opening new stores and improving our existing stores and making investments in our distribution network and (iii) funding working capital requirements. The most significant components of our working capital are cash and cash equivalents, merchandise inventories, accounts payable and other current liabilities.

 

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Operating Activities

 

    

For the Year Ended

 
(Dollars in millions)    February 2,
2019
    February 3,
2018
    January 28,
2017
 

Net loss

   $ (67.8   $ (71.7   $ (70.4

Adjustments to reconcile to cash flows from operating activities:

      

Depreciation of property and equipment

       88.0       101.3       109.5  

Impairment losses

     10.8       141.2       7.8  

Amortization of intangible assets

     7.2       9.1       10.5  

Amortization of deferred financing costs and debt discount

     3.7       5.2       6.9  

Reclassification of hedging losses to earnings

     2.4       10.7       10.5  

Share-based compensation

     0.2       2.3       1.0  

Loss on sale of property

     —         0.5       —    

Deferred income taxes

     —         (129.3     2.5  

Foreign currency transaction gains

     (0.4     (1.4     (1.5

Changes in merchandise inventories, net

     (98.5     22.6       57.8  

Changes in accounts payable and other liabilities

     95.8       21.4       (17.4

Changes in operating assets and liabilities

     (34.5     (31.4     20.7  
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

   $ 6.9     $ 80.5     $ 137.9  
  

 

 

   

 

 

   

 

 

 

Cash provided by operating activities of $6.9 million in fiscal 2018 resulted from: (i) non-cash adjustments of $111.9 million, partially offset by (ii) a net loss of $67.8 million and (iii) changes in operating assets and liabilities of $37.2 million, primarily due to an increase in merchandise inventories as a result of an anticipated increase in revenues. During the fourth quarter of fiscal 2018, we recorded a charge of $39.3 million for expected losses on the disposition of excess merchandise inventories.

Cash provided by operating activities of $80.5 million in fiscal 2017 resulted from: (i) non-cash adjustments of $139.6 million and (ii) changes in operating assets and liabilities of $12.6 million due to working capital fluctuations, partially offset by (iii) net loss of $71.7 million.

Cash provided by operating activities of $137.9 million in fiscal 2016 resulted from: (i) non-cash adjustments of $147.2 million and (ii) changes in operating assets and liabilities of $61.1 million due to working capital fluctuations, partially offset by (iii) net loss of $70.4 million.

Investing Activities

 

    

For the Year Ended

 
(Dollars in millions)    February 2,
2019
     February 3,
2018
     January 28,
2017
 

Capital expenditures:

        

Information technology

   $ (23.2    $ (21.4    $ (29.7

New stores and store improvements

     (15.9      (15.7      (39.4

Corporate headquarters relocation

     (8.8      —          —    

Other(a)

     (4.8      (2.5      (11.0

Proceeds from sale of property

     —          2.5        —    
  

 

 

    

 

 

    

 

 

 

Net cash used in investing activities

   $ (52.7    $ (37.1    $ (80.1
  

 

 

    

 

 

    

 

 

 

 

(a)

Includes capital expenditures for warehouse improvements and general corporate purposes.

Capital expenditures are planned at approximately $60 to $70 million for fiscal 2019, including approximately $25 million for our corporate headquarters relocation, approximately $20 million for information

 

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technology enhancements, $20 million for new stores and store improvements, and the remainder for warehouse improvements and general corporate purposes.

Financing Activities

 

    

For the Year Ended

 
(Dollars in millions)    February 2,
2019
    February 3,
2018
    January 28,
2017
 

Repayments of debt

   $ (82.4   $ (38.3   $ (11.8

Dividends on preferred stock

     (9.6     (1.6     —    

Cost paid in connection with refinancings of debt

     (0.1     (0.7     (1.1

Net borrowings under the ABL Facility

        70.8       —         —    

Proceeds from Notes, net of discount

     —         123.5       —    

Repayments pursuant to the Term Loan amendment

     —         (150.5     —    
  

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

   $ (21.3   $ (67.6   $ (12.9
  

 

 

   

 

 

   

 

 

 

Cash used in financing activities was $21.3 million in fiscal 2018 resulting primarily from: (i) repayments of debt, offset by (ii) net borrowings under the ABL Facility.

Cash used in financing activities was $67.6 million in fiscal 2017 resulting from: (i) repayments pursuant to the Term Loan amendment, offset by (ii) the proceeds from the issuance of the Notes (as defined below).

Cash used in financing activities was $12.9 million in fiscal 2016 resulting from: (i) principal repayments of the Term Loan Facility and (ii) costs paid in connection with the refinancing of debt.

Debt Exchange and Refinancing

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

 

   

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

 

   

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

 

   

189,688 shares of our pre-Reorganization 7% non-convertible perpetual series A preferred stock, no par value per share, with an aggregate initial liquidation preference of $189,688,000; and

 

   

15%, or 17,362,719 shares, of our pre-Reorganization class A common stock, $0.00001 par value per share;

 

   

certain amendments to the indenture governing the PIK Notes;

 

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

 

   

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

 

   

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

 

   

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

 

   

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

We accounted for the Exchange Offer in accordance with ASC 470 – Debt, which resulted in a portion of the exchange to be considered a TDR. Accordingly, pursuant to such guidance for a TDR, future interest payments of $219.8 million were recognized as debt on the consolidated balance sheet at the date of the Exchange Offer. As these future payments are made, we will record these distributions as a reduction of debt, and will not recognize interest expense on the consolidated statement of operations.

Financing Arrangements

ABL Facility

We have an ABL Facility, which is governed by a credit agreement with Bank of America, N.A., as administrative agent, and the other agents and lenders party thereto, that, following the Sixth Amendment described below, provides for a $375 million senior secured asset-based revolving line of credit (which may be increased by up to $75 million in certain circumstances), subject to a borrowing base limitation. We cannot borrow in excess of $375 million under the ABL Facility without the consent of holders of at least a majority of the loans outstanding under our Term Loan Facility. The borrowing base under the ABL Facility equals the sum of: 90% of the eligible credit card receivables; plus, 85% of eligible accounts; plus, 90% (or 92.5% for the period of August 1 through December 31 of any fiscal year) of the net recovery percentage of eligible inventory multiplied by the cost of eligible inventory; plus 85% of the net recovery percentage of eligible letters of credit inventory, multiplied by the cost of eligible letter of credit inventory; plus, 85% of the net recovery percentage of eligible in-transit inventory, multiplied by the cost of eligible in-transit inventory; plus, 100% of qualified cash; minus, all availability and inventory reserves. The ABL Facility includes borrowing capacity in the form of letters of credit up to $200 million, and up to $25 million in U.S. dollars for loans on same-day notice, referred to as swingline loans, and is available in U.S. dollars, Canadian dollars and Euros. Any amounts outstanding under the ABL Facility are due and payable in full on the maturity date of November 17, 2021.

On September 19, 2018, we entered into a Sixth Amendment to Credit Agreement (Incremental Amendment) (the “Sixth Amendment”), which amended the ABL Facility to increase the revolving credit

 

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commitment from $350 million to $375 million, with the additional $25 million provided by MUFG Union Bank, N.A., which joined the ABL Facility as an additional lender.

On February 2, 2019, standby letters of credit were $64.7 million, outstanding borrowings were $70.8 million, and excess availability, as defined, was $233.7 million. The weighted average interest rate on the borrowings outstanding under the ABL Facility was 5.05% on February 2, 2019. Average short-term borrowings under the ABL Facility were $70.3 million and $9.1 million in fiscal 2018 and fiscal 2017, respectively.

See note 11 to the historical consolidated financial statements of Chinos Holdings for a further description of the terms of the ABL Facility.

Demand Letter of Credit Facility

We have an unsecured demand letter of credit facility with HSBC which provides for the issuance of up to $20 million of documentary letters of credit on a no fee basis. On February 2, 2019, outstanding documentary letters of credit were $6.4 million and availability under this facility was $13.6 million.

Term Loan Facility

2017 Amendment. On July 13, 2017, concurrently with the settlement of the Exchange Offer, we amended our Term Loan Facility to, among other things, (i) increase the interest rate applicable to the loans held by consenting lenders, which represented 88% of lenders, (the “Consenting Lenders”; and the loans held by the Consenting Lenders, the “Amended Loans”) by 22 basis points, (ii) increase the amount of amortization payable to Consenting Lenders, (iii) provide for the New Term Loan Borrowings of $30.0 million, (iv) amend certain covenants and events of default and (v) direct Wilmington Savings Fund Society, FSB, as administrative agent under the Term Loan Facility, to dismiss, with prejudice, certain litigation regarding the Initial Transferred IP (and the related actions). Additionally, we repaid $150.5 million of principal amount of term loans outstanding under the Term Loan Facility, which was financed with (i) the net proceeds from the New Money Notes of $94.1 million, (ii) the net proceeds from the New Term Loan Borrowings of $29.4 million and (iii) cash on hand of $27.0 million.

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

The weighted average interest rate on the borrowings outstanding under the Term Loan Facility was 6.18% on February 2, 2019. The applicable margin (i) in effect for base rate borrowings was, (x) in the case of term loans, other than the New Term Loan Borrowings and the Amended Loans, 2.00%, (y) in the case of the Amended Loans, 2.22% and (z) in the case of the New Term Loan Borrowings, 12.00% (of which 3.00% is payable in kind) and (ii) with respect to LIBOR borrowings was, (x) in the case of term loans, other than the New Term Loan Borrowings and the Amended Loans, 3.00% and the LIBOR Floor, (y) in the case of the Amended Loans, 3.22% and the LIBOR Floor and (z) in the case of the New Term Loan Borrowings, 12.00% (of which 3.00% is payable in kind), respectively, at February 2, 2019.

Principal Repayments. We are required to make principal repayments equal to 0.25% of the original principal amount of the Term Loan Facility (excluding the New Term Loan Borrowings), or $3.9 million, on the last business day of January, April, July, and October. We are also required (i) to repay the term loan based on an

 

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annual calculation of excess cash flow, as defined in the agreement, (ii) in the second quarter of fiscal 2019, to make a principal repayment of $11.9 million which is equal to 1.00% of the aggregate principal amount of Amended Loans outstanding on July 13, 2017 and (iii) beginning on July 31, 2019, on the last business day of January, April, July and October, to make additional principal repayments of $1.5 million equal to 0.125% of the aggregate principal amount of Amended Loans outstanding on July 13, 2017. The maturity date of the Term Loan Facility is March 5, 2021.

Notes

General. On July 13, 2017, in connection with settlement of the Exchange Offer and the issuance of the Notes, J.Crew Brand, LLC and J.Crew Brand Corp. (together, the “Notes Co-Issuers”) and the Guarantors (as defined below) entered into (i) an indenture with U.S. Bank National Association, as Trustee and collateral agent, governing the terms of the Exchange Notes (the “Exchange Notes Indenture”) and (ii) an indenture with the Trustee and U.S. Bank, as collateral agent, governing the terms of the New Money Notes (the “New Money Notes Indenture”), which is in substantially the same form as the Exchange Notes Indenture.

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

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

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

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

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

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

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

 

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PIK Notes

In the fourth quarter of fiscal 2013, the PIK Notes Issuer, a direct wholly-owned subsidiary of the Company, issued $500 million of PIK Notes. As part of the refinancing in July 2017, $565.7 million in aggregate principal amount of the PIK Notes were exchanged for $249.6 million of Exchange Notes and shares of our preferred and common stock. As of February 2, 2019, there were $1.0 million in aggregate principal amount of PIK Notes outstanding. The PIK Notes are: (i) senior unsecured obligations of the PIK Notes Issuer, (ii) structurally subordinated to all of the liabilities of the PIK Notes Issuers’ subsidiaries, and (iii) not guaranteed by any of the PIK Notes Issuers’ subsidiaries.

IP License Agreements

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

Under the IP License Agreements, J.Crew Operating Corp, (“OpCo”), our direct wholly-owned subsidiary, pays a fixed license fee of $59 million per annum to IPCo, which owns the U.S. intellectual property rights of the J.Crew brand. The license fees are payable on March 1 and September 1 of each fiscal year. The terms of the 2017 IP License Agreements are no less favorable than could be obtained in an arm’s length transaction with an unaffiliated third party. These royalty payments have no impact on our consolidated results of operations and are not subject to the covenants under our credit facilities or the PIK Notes.

The proceeds from the license fees to IPCo are used by IPCo and J.Crew Brand, LLC, wholly-owned subsidiaries of the Company (collectively, “J.Crew BrandCo”), to meet debt service requirements on the Notes. Any license fees in excess of the debt service requirements are loaned back to OpCo on a subordinated basis.

Quantitative and Qualitative Disclosures About Market Risk

Interest Rates

We are exposed to interest rate risk arising from changes in interest rates on the floating rate indebtedness under our Senior Credit Facilities. Borrowings pursuant to our Term Loan Facility bear interest at floating rates based on LIBOR, but in no event less than the floor rate of 1.00%, plus the applicable margin. Borrowings pursuant to our ABL Facility bear interest at floating rates based on LIBOR and the prime rate, plus the applicable margin. Accordingly, fluctuations in market interest rates may increase or decrease our interest expense which will in turn, increase or decrease our net income or net loss and cash flow.

We manage a portion of our interest rate risk related to floating rate indebtedness by entering into interest rate swaps whereby we receive floating rate payments based on the greater of LIBOR and the floor rate and make payments based on a fixed rate. Our interest rate swap agreements cover a notional amount of $800 million from March 2016 to March 2019. Under the terms of these agreements, our effective fixed interest rate on the notional amount of indebtedness is 2.56% plus the applicable margin.

In October 2018, we entered into a new interest rate swap agreement which covers a notional amount of $750 million from March 2019 to March 2020. Under the terms of this agreement, our effective fixed interest rate on the notional amount of indebtedness is 3.03% plus the applicable margin.

 

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As a result of the floor rate described above, we estimate that a 1% increase in LIBOR would increase our annual interest expense by $6 million.

Foreign Currency

Foreign currency exposures arise from transactions denominated in a currency other than the entity’s functional currency. Although our inventory is primarily purchased from foreign vendors, such purchases are denominated in U.S. dollars and are therefore not subject to foreign currency exchange risk. However, we operate in foreign countries, which exposes us to market risk associated with exchange rate fluctuations. We are exposed to foreign currency exchange risk resulting from our foreign operating subsidiaries’ U.S. dollar denominated transactions.

Off Balance Sheet Arrangements

We enter into documentary letters of credit to facilitate a portion of our international purchase of merchandise. We also enter into standby letters of credit to secure reimbursement obligations under certain insurance and import programs and lease obligations. As of February 2, 2019, we had the following obligations under letters of credit in future periods.

 

Letters of Credit

  

Total

    

Within

1 Year

    

2-3

Years

    

4-5

Years

    

After 5

Years

 
(Dollars in millions)                                   

Standby

   $ 64.7      $ 64.6      $ 0.1      $   —        $   —    

Documentary

     6.4        6.4        —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 71.1      $ 71.0      $ 0.1      $ —        $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Contractual Obligations

The following table summarizes our contractual obligations as of February 2, 2019 and the effect such obligations are expected to have on our liquidity and cash flows in future periods:

 

    

Total

    

Within

1 Year

    

2-3

Years

    

4-5

Years

    

After 5

Years

 
(Dollars in millions)                                   

Operating lease obligations(a)

   $ 899.8      $ 146.3      $ 253.5      $ 186.2      $ 313.8  

Liabilities associated with uncertain tax positions(b)

              

Purchase obligations:

              

Inventory commitments

     502.0        502.0        —          —          —    

Other contractual obligations(c)

     63.8        20.1        28.1        15.6        —    

Employment agreements

     14.9        12.5        2.4        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total purchase obligations

     580.7        534.6        30.5        15.6        —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Debt(d)(e)

     1,945.8        170.1        1,775.7        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,426.3      $ 851.0      $ 2,059.7      $ 201.8      $ 313.8  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(a)

Operating lease obligations represent obligations under various long-term operating leases entered in the normal course of business for retail and factory stores, office space and equipment requiring minimum annual rentals. Operating lease expense is a significant component of our operating expenses. The lease terms range for various periods of time in various rental markets and are entered into at different times, which mitigates exposure to market changes that could have a material effect on our results of operations within any given year. Operating lease obligations do not include common area maintenance, insurance, taxes and other occupancy costs, which aggregate to approximately 44% of the minimum lease obligations.

 

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(b)

As of February 2, 2019, we have recorded $23.6 million in liabilities associated with uncertain tax positions, which are included in other liabilities on the consolidated balance sheet. While these tax liabilities may result in future cash outflows, management cannot make reliable estimates of the cash flows by period due to the inherent uncertainty surrounding the effective settlement of these positions.

(c)

Relates primarily to commitments incurred in connection with our e-commerce platform.

(d)

Debt includes principal payments on our Term Loan Facility, Notes and PIK Notes, and future interest payments recorded as debt in accordance with accounting guidance for troubled debt restructurings. Additionally, it includes $70.8 million of borrowings outstanding as of February 2, 2019 under a $375 million ABL Facility. The amount reflected does not take into account any amounts that may be required to be prepaid from time to time based on our excess cash flow.

(e)

Amounts shown do not include interest, except for future payments recorded as debt discussed in footnote (d).

Impact of Inflation

Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our results of operations and financial condition have not been significant.

Recent Accounting Pronouncements

In February 2016 and July 2018, pronouncements were issued with respect to the accounting for leases. Effective for fiscal years beginning after December 15, 2018, the pronouncements require lessees to recognize right-of-use lease assets (“ROU assets”) and right-of-use lease liabilities (“ROU liabilities”) for leases with terms of more than one year. The ROU liabilities are measured as the present value of the lease obligations. The ROU assets reflect the amount of the ROU liabilities less lease-related deferred credits. Upon adoption of the new standard in the first quarter of fiscal 2019, we recorded a significant gross-up to the balance sheet, including ROU assets of $533.5 million and ROU liabilities of $624.6 million. We used the effective date method whereby initial application occurred on the date of adoption with comparative periods unchanged. Additionally, we utilized the package of practical expedients permitted by the transition guidance, which allowed for a carryforward of our identification of leases, historical lease classification and initial direct costs for existing leases. We elected to use hindsight in determining lease term.

In August 2018, a pronouncement was issued that modifies the disclosure requirements on fair value measurements. The pronouncement is effective for annual and interim periods in fiscal years beginning after December 15, 2019. We are currently evaluating the impact of the new pronouncement on our consolidated financial statements.

Critical Accounting Policies

Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and expenses. Management bases estimates on historical experience and other assumptions it believes to be reasonable under the circumstances and evaluates these estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.

The following critical accounting policies reflect the significant estimates and judgments used in the preparation of our consolidated financial statements. With respect to critical accounting policies, even a relatively minor variance between actual and expected experience can potentially have a materially favorable or

 

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unfavorable impact on subsequent consolidated results of operations. For more information on our accounting policies, please refer to the notes to consolidated financial statements included elsewhere in this prospectus.

Revenue Recognition

 

   

We recognize sales made in our stores at the point of sale, sales through our e-commerce business at the date of receipt by a customer and sales to a wholesale customer at the time ownership is transferred. Amounts billed to customers for shipping and handling sales are classified as DTC revenues. We make estimates of future sales returns related to current period sales. Management analyzes historical returns, current economic trends and changes in customer acceptance of our products when evaluating the adequacy of the reserve for sales returns. We record an asset in other current assets for the inventory expected to be returned and a liability in other current liabilities for the sales expected to be refunded. On the statement of operations, we present the change in the liability in total revenues and the change in the asset in cost of goods sold.

 

   

Employee discounts are classified as a reduction of revenue.

 

   

We account for gift cards by recognizing a liability at the time a gift card is sold and recognizing revenue at the time the gift card is redeemed for merchandise. We review our gift card liability on an ongoing basis and recognize income from unredeemed gift card liability on a ratable basis over the estimated period of redemption. We defer revenue and recognize a liability for rewards points issued in connection with our customer loyalty program for the rewards points expected to be redeemed for merchandise in the future.

Inventory Valuation

Merchandise inventories are carried at the lower of average cost or net realizable value. We capitalize certain design, purchasing and warehousing costs in inventory. We evaluate all of our inventories to determine excess inventories based on estimated future sales. Excess inventories may be disposed of through our e-commerce business, factory stores and other liquidation methods. Based on historical results experienced through various methods of disposition, we write down the carrying value of inventories that are not expected to be sold at or above cost. Additionally, we reduce the cost of inventories based on an estimate of lost or stolen items each period.

At the end of fiscal 2018, we owned substantial excess merchandise inventories. As a result, we recorded a charge of $39.3 million for expected losses on the disposition of those inventories.

Goodwill and Intangible Assets

Indefinite-lived intangible assets, such as the J.Crew trade name and goodwill, are not subject to amortization. We assess the recoverability of indefinite-lived intangibles whenever there are indicators of impairment, or at least annually in the fourth quarter. If the recorded carrying value of an intangible asset exceeds its estimated fair value, we record a charge to write the intangible asset down to its fair value. Definite-lived intangibles, such as the Madewell trade name and favorable lease commitments, are amortized on a straight-line basis over their useful life or remaining lease term.

We assess the recoverability of goodwill at the reporting unit level, which consists of our operating segments, J.Crew and Madewell, of which only Madewell has goodwill. In this assessment, we first compare the estimated enterprise fair value of the Madewell reporting unit to its recorded carrying value. We estimate the enterprise fair value based on a combination of an income approach, specifically the discounted cash flow, a market approach, and a transaction approach. If the recorded carrying value of the Madewell reporting unit exceeds its estimated enterprise fair value in the first step, a second step is performed in which we allocate the

 

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enterprise fair value to the fair value of Madewell’s net assets. The second step of the impairment testing process requires, among other things, estimates of fair values of substantially all of our tangible and intangible assets. Any enterprise fair value in excess of amounts allocated to such net assets represents the implied fair value of goodwill for Madewell. If the recorded goodwill balance for Madewell exceeds the implied fair value of goodwill, an impairment charge is recorded to write goodwill down to its fair value.

Fixed Asset Impairment

We are exposed to potential impairment if the book value of our assets exceeds their expected undiscounted future cash flows. The major components of our long-lived assets are store fixtures, equipment and leasehold improvements. We test for impairment at the store level and the net book value is reduced to fair value if it is determined that the sum of expected discounted future net cash flows is less than net book value.

In fiscal 2018, we recorded non-cash impairment charges of $10.8 million related to certain long-lived assets.

Income Taxes

An asset and liability method is used to account for income taxes. Deferred tax assets and deferred tax liabilities are recognized based on the difference between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred taxes are measured using current enacted tax rates in effect in the years in which those temporary differences are expected to reverse. Inherent in the measurement of deferred taxes are certain judgments and interpretations of enacted tax law and published guidance.

We maintain valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in the valuation allowances are included in our tax provision in the period of change. In determining whether a valuation allowance is warranted, we evaluate factors such as prior earnings history, expected future earnings, carry-back and carry-forward periods and tax strategies that could potentially enhance the likelihood of the realization of a deferred tax asset.

With respect to uncertain tax positions that we have taken or expect to take on a tax return, we recognize in our financial statements the impact of tax positions that meet a “more likely than not” threshold, based on the technical merits of the position. The tax benefits recognized from uncertain positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon effective settlement.

Derivative Financial Instruments

We entered into interest rate swap agreements to manage a portion of our interest rate risk related to floating rate indebtedness. As cash flow hedges, unrealized gains are recognized as assets while unrealized losses are recognized as liabilities. The interest rate swap agreements are highly correlated to the changes in interest rates to which we are exposed. Unrealized gains and losses on this instrument are designated as effective or ineffective. The effective portion of such gains or losses is recorded as a component of accumulated other comprehensive loss, while the ineffective portion of such gains or losses is recorded as a component of interest expense. Realized gains and losses in connection with each required interest payment are reclassified from accumulated other comprehensive loss to interest expense.

 

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CHINOS HOLDINGS BUSINESS

The businesses of Chinos Holdings described in this section represent the combined J.Crew business and Madewell business. The J.Crew business will not be owned by investors in this offering following the Reorganization. An investment in us in this offering is an investment in the Madewell business. As used in this section only, unless the context requires otherwise, “Chinos Holdings” the “Company,” “we,” “us” or “our” refer to Chinos Holdings, Inc. and its consolidated subsidiaries, “Madewell” refers to the Madewell business and “J.Crew” refers to the J.Crew business, in each case, before giving effect to the Reorganization. For a description of the Madewell business, see “Additional Information Related to the Madewell Business—Madewell Business.”