S&P upgrades J. Crew, rates new notes CCC

Standard & Poor's briefly downgraded J. Crew Group Inc. then upgraded it. Actions include cutting the corporate credit rating to SD from CC, then raising it to B-, cutting the $142 million 13.125% senior discount debentures due 2008 to D from CC, confirming J. Crew Corp.'s $150 million 10.375% senior subordinated notes due 2007 at CC, then upgrading them to CCC and assigning a CCC to J. Crew Intermediate LLC's $120 million 16% senior subordinated discount contingent principal notes due 2008. All ratings were removed from CreditWatch negative. Then a negative outlook was assigned.

S&P said the initial downgrades reflect completion of an exchange offer on the outstanding 13 1/8% senior discount debentures due 2008 issued by the company for 16.0% senior discount contingent principal notes due 2008. S&P said it believes the offer is distressed and therefore is tantamount to a default.

For the upgrades that follow, S&P said the action reflects J. Crew's improved near-term financial flexibility due to a sharp cutback in capital expenditures and the exchange of its cash pay 13 1/8% debentures for non-cash pay notes. These actions should provide the new management with an opportunity to turn around operations.

The ratings on J. Crew reflect the high business risk associated with its participation in the intensely competitive apparel retailing industry and leveraged balance sheet. These risks are partially mitigated by the company's good market position in catalog and store retailing, S&P added.

The company's operating performance has been poor for more than two years. Same store sales decreased 10.4% in 2002 following a 15.5% drop in 2001 and operating margins fell to 12.2% in 2002 from 12.3% in 2001 and 14.8% in 2000, S&P said. The margin erosion is attributable to a lack of sales leverage and higher markdowns. From 1998 to 2000, the company improved its operating performance through a combination of leveraging its core brand across its retail, catalog, Internet, and outlet distribution channels; exiting noncore businesses; higher initial mark-ups on merchandise; and better inventory management.

The poor operating performance for the past two years has hurt credit protection measures. In 2002, EBITDA coverage of interest was only 1.1x and funds from operations to total debt was 7.9%, S&P said. The company is likely to continue to be challenged by the soft U.S. economy and the intensely competitive retail environment. Leverage is very high with total debt to EBITDA at 7.9x.

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