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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended January 29, 2000
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _________ to __________
Commission File Number: 0-25716
FINLAY ENTERPRISES, INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-3492802
- -------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
529 Fifth Avenue New York, NY 10017
- ----------------------------------------- ----------
(Address of principal executive offices) (zip code)
212-808-2800
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
-------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [x]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing price on the Nasdaq National Market for such
shares on April 24, 2000 was $84,764,312.
As of April 24, 2000, there were 10,421,353 shares of common stock, par value
$.01 per share, of the registrant outstanding.
Documents incorporated by reference:
Portions of the Company's definitive Proxy Statement, in connection with its
Annual Meeting to be held in June 2000, are incorporated by reference into Part
III. The Company's Proxy Statement will be filed within 120 days after January
29, 2000.
FINLAY ENTERPRISES, INC
FORM 10-K
FOR THE FISCAL YEAR ENDED JANUARY 29, 2000
INDEX
Page(s)
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PART I
Item 1. Business.............................................................3
Item 2. Properties..........................................................15
Item 3. Legal Proceedings...................................................15
Item 4. Submission of Matters to a Vote of Security Holders.................15
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters..........................................................16
Item 6. Selected Consolidated Financial Data................................17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..............................19
Item 7a. Quantitative and Qualitative Disclosures about Market Risk..........29
Item 8. Financial Statements and Supplementary Data.........................30
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..............................30
PART III
Item 10. Directors and Executive Officers of the Registrant..................31
Item 11. Executive Compensation..............................................34
Item 12. Security Ownership of Certain Beneficial Owners and Management......34
Item 13. Certain Relationships and Related Transactions......................37
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.....38
SIGNATURES ...................................................................45
2
PART I
Item 1. Business
The Company
Finlay Enterprises, Inc., a Delaware corporation (the "Company"), conducts
business through its wholly owned subsidiary, Finlay Fine Jewelry Corporation, a
Delaware corporation, and its wholly owned subsidiaries ("Finlay Jewelry").
References to "Finlay" mean, collectively, the Company, Finlay Jewelry and all
predecessor businesses. All references herein to "Departments" refer to fine
jewelry departments operated pursuant to license agreements or other
arrangements with host department stores.
Finlay is one of the leading retailers of fine jewelry in the United
States. The Company operates leased fine jewelry departments ("Departments") in
major department stores for retailers such as The May Department Stores Company
("May"), Federated Department Stores ("Federated"), Belk, the Carson Pirie Scott
and Proffitt"s divisions of Saks Incorporated, Marshall Field's and Dillard's.
With the recent acquisition of certain assets of Jay B. Rudolph, Inc. ("J.B.
Rudolph"), Finlay also now operates Departments in Bloomingdale's, Dayton's and
Hudson's. Finlay sells a broad selection of moderately priced fine jewelry,
including necklaces, earrings, bracelets, rings and watches, and markets these
items principally as fashion accessories with an average domestic sales price of
approximately $170 per item. Average domestic sales per Department were $911,000
in 1999 and the average size of a Department is approximately 700 square feet.
Finlay's sales have increased from $654.5 million in 1995 to $913.0 million
in 1999, a compound annual growth rate of 8.7%. Income from operations has
increased from $48.3 million to $67.1 million in the same period (excluding the
1999 Sonab nonrecurring charge described below), a compound annual growth rate
of 8.6%. Finlay has increased in size from 903 locations at the beginning of
1995 to 979 Departments and 8 stand-alone stores, for a total of 987 locations
at the end of 1999.
As of January 29, 2000, Finlay operated its 987 locations in 24 host store
groups, in 44 states and the District of Columbia. Finlay's largest host store
relationship is with May, for which Finlay has operated Departments since 1948.
Finlay operates the fine jewelry departments in all of May's 406 department
stores. Finlay's second largest host store relationship is with Federated, for
which Finlay has operated Departments since 1983. Finlay operates Departments in
155 of Federated's 403 department stores. Over the past three years, store
groups owned by May and Federated accounted for an average of 48% and 22%,
respectively, of Finlay's domestic sales. Management believes that it maintains
excellent relations with its host store groups, 20 of which have had leases with
Finlay for more than five years (representing 88% of Finlay's domestic sales in
1999) and 15 of which have had leases with Finlay for more than ten years
(representing 73% of Finlay's domestic sales in 1999).
On April 3, 2000, Finlay completed the acquisition of certain assets of
J.B. Rudolph (the "J.B. Rudolph Acquisition") for $21.1 million, subject to
certain post-closing adjustments. By acquiring J.B. Rudolph, Finlay added 57
Departments that had total sales of approximately $84 million in 1999, and also
added new host store relationships with Bloomingdale's, Dayton's and Hudson's.
Management believes that the J.B. Rudolph Acquisition, in addition to increasing
sales volume, will improve Finlay's results of operations through the leveraging
of expenses and the achievement of other operating synergies.
On January 3, 2000, Societe Nouvelle d'Achat de Bijouterie - S.O.N.A.B.
("Sonab"), the Company's European leased jewelry department subsidiary, sold the
majority of its assets for $9.9 million. After the sale, the buyer operated more
than 80 locations previously included in Sonab's 130-location base in France.
The remaining departments were closed. The Company recorded a pre-tax charge of
$28.6
3
million, or $1.62 per share on a diluted basis after-tax, for the write-down of
assets for disposition and related closure expenses. The cash portion of this
charge was approximately $7.8 million.
As of January 29, 2000, Finlay operated eight domestic stand alone jewelry
outlet stores at nonmetropolitan outlet shopping center locations in New York,
Florida, South Carolina, Pennsylvania, Georgia and California under the name
"New York Jewelry Outlet".
On April 24, 1998, the Company completed a public offering of 1,800,000
shares of its common stock, par value $.01 per share ("Common Stock"), at a
price of $27.50 per share (the "1998 Offering"), of which 567,310 shares were
sold by the Company. Concurrently with the 1998 Offering, the Company and Finlay
Jewelry completed the public offering of $75.0 million aggregate principal
amount of 9% Senior Debentures due May 1, 2008 (the "Senior Debentures") and
$150.0 million aggregate principal amount of 83/8% Senior Notes due May 1, 2008
(the "Senior Notes"), respectively. In addition, on April 24, 1998, Finlay's
revolving credit agreement (the "Revolving Credit Agreement") was amended to
increase the line of credit thereunder to $275.0 million and to make certain
other changes.
On May 26, 1998, the net proceeds to the Company from the 1998 Offering,
the sale of the Senior Debentures, together with other available funds, were
used to redeem the Company's 12% Senior Discount Debentures due 2005 (the "Old
Debentures"), including associated premiums. Also, on May 26, 1998, Finlay
Jewelry used the net proceeds from the sale of the Senior Notes to redeem Finlay
Jewelry's 105/8% Senior Notes due 2003 (the "Old Notes"), including associated
premiums. The above transactions, excluding the 1998 Offering, are referred to
herein as the "Refinancing". The Company recorded, in the second quarter of
1998, a pre-tax extraordinary charge of $12.2 million, including $7.1 million
for redemption premiums and $3.9 million to write off deferred financing costs
and debt discount associated with the Old Debentures and the Old Notes.
On October 6, 1997, Finlay completed the acquisition of certain assets of
the Diamond Park Fine Jewelers division of Zale Corporation ("Diamond Park"), a
leading operator of Departments, for approximately $63.0 million. By acquiring
Diamond Park (the "Diamond Park Acquisition"), Finlay added 139 Departments and
also added new host store relationships with Marshall Field's, Parisian and
Dillard's, formerly the Mercantile Stores.
Finlay's fiscal year ends on the Saturday closest to January 31. References
to 1995, 1996, 1997, 1998, 1999 and 2000 relate to the fiscal years ending on
February 3, 1996, February 1, 1997, January 31, 1998, January 30, 1999, January
29, 2000 and February 3, 2001, respectively. Each of the fiscal years includes
52 weeks except 1995 and 2000, which include 53 weeks.
The Company is a holding company and has no operations of its own. The
primary asset of the Company is the common stock of Finlay Jewelry, which
conducts all of Finlay's operations. The principal executive offices of the
Company are located at 529 Fifth Avenue, New York, New York 10017 and its
telephone number at this address is (212) 808-2800.
General
Overview. Host stores benefit from outsourcing the operation of their fine
jewelry departments. By engaging Finlay, host stores gain specialized
managerial, merchandising, selling, marketing, inventory control and security
expertise. Additionally, by avoiding the high working capital investment
typically required of the jewelry business, host stores improve their return on
investment and can potentially increase their profitability.
4
As a lessee, Finlay benefits from the host stores' reputation, customer
traffic, advertising, credit services and established customer base. Finlay also
avoids the substantial capital investment in fixed assets typical of stand-alone
retail formats. These factors have generally enabled Finlay's new Departments to
achieve profitability within their first twelve months of operation. Finlay
further benefits because net sales proceeds are generally remitted to Finlay by
each host store on a monthly basis with essentially all customer credit risk
borne by the host store.
As a result of Finlay's strong relationships with its vendors, management
believes that the Company's working capital requirements are lower than those of
many other jewelry retailers. In recent years, on average, approximately 50% of
Finlay's domestic merchandise has been carried on consignment. The use of
consignment merchandise also reduces Finlay's inventory exposure to changing
fashion trends because, in general, unsold consigned merchandise can be returned
to the vendor.
Industry. Management believes that current trends in jewelry retailing,
particularly in the department store sector, provide a significant opportunity
for Finlay's growth. Consumers spent approximately $47.7 billion on jewelry
(including both fine and costume jewelry) in the United States in 1999, an
increase of approximately $18.6 billion over 1989, according to the United
States Department of Commerce. In the department store sector in which Finlay
operates, consumers spent $4 billion on fine jewelry in 1998. Management
believes that demographic factors such as the maturing of the U.S. population
and an increase in the number of working women have resulted in greater
disposable income, thus contributing to the growth of the fine jewelry retailing
industry. Management also believes that jewelry consumers today increasingly
perceive fine jewelry as a fashion accessory, resulting in purchases which
augment the Company's gift and special occasion sales. Finlay's Departments are
typically located in "high traffic" areas of leading department stores, enabling
Finlay to capitalize on these consumer buying patterns.
Growth Strategy. Finlay intends to continue to pursue the following key
initiatives to increase sales and earnings:
Increase Comparable Department Sales. In 1997, 1998 and 1999, Finlay
achieved domestic comparable Department sales increases of 5.7%, 5.4% and
8.1%, respectively, outpacing the majority of its host stores. These
increases were achieved primarily by emphasizing key merchandise items,
increasing focus on holiday and event-driven promotions, participating in
host store marketing programs and positioning its Departments as a
"destination location" for fine jewelry. Finlay believes that comparable
Department sales will continue to benefit from these merchandising and
marketing strategies, as well as from increasing demand for fine jewelry.
Add Departments Within Existing Host Store Groups. Finlay's well
established relationships with many of its host store groups have enabled
the Company to add Departments in new locations opened by existing host
stores. Finlay has operated Departments in May stores since 1948 and
operates the fine jewelry departments in all of May's 406 department
stores. Finlay also has operated Departments in Federated stores since 1983
and operates Departments in 155 of Federated's 403 department stores. Based
on May's expansion plans, Finlay believes it will have the opportunity to
open approximately 80 new Departments in May stores alone over the next
five years (excluding possible closings).
Establish New Host Store Relationships. Finlay has an opportunity to grow
primarily by establishing new relationships with department stores that
presently operate their own fine jewelry departments. Finlay seeks to
establish these new relationships by demonstrating to department store
management the potential for improved financial performance. Since the
beginning of 1992, Finlay has added such host store groups as Burdines, The
Bon Marche, Elder Beerman and Stern's.
5
Through acquisitions since October 1997, Finlay has added Marshall Field's,
Parisian, Dillard's, Bloomingdale's, Dayton's and Hudson's to its host
store relationships.
Continue to Improve Operating Leverage. Selling, general and administrative
expenses as a percentage of sales declined from 43.2% in 1995 to 41.5% in
1999. Finlay seeks to continue to leverage expenses both by increasing
sales at a faster rate than expenses and by reducing its current level of
certain operating expenses. For example, Finlay has demonstrated that by
increasing the selling space (with host store approval) of certain high
volume Departments, incremental sales can be achieved without having to
incur proportionate increases in selling and administrative expenses. In
addition, management believes the Company will benefit from further
investments in technology and refinements of operating procedures designed
to allow Finlay's sales associates more time for customer sales and
service. Finlay's central distribution facility, which became fully
operational in the Spring of 1998, has enabled the Company to improve the
flow of merchandise to Departments and to reduce payroll and freight costs.
Merchandising Strategy. Finlay seeks to maximize sales and profitability
through a unique merchandising strategy known as the "Finlay Triangle", which
integrates store management (including host store management and Finlay's store
group management), vendors and Finlay's central office. By coordinating efforts
and sharing access to information, each Finlay Triangle participant plays a role
which emphasizes its area of expertise in the merchandising process, thereby
increasing productivity. Within guidelines set by the central office, Finlay's
store group management contributes to the selection of the specific merchandise
most appropriate to the demographics and customer tastes within their particular
geographical area. Finlay's advertising initiatives and promotional planning are
closely coordinated with both host store management and Finlay's store group
management to ensure the effective use of Finlay's marketing programs. Vendors
participate in the decision-making process with respect to merchandise
assortment, including the testing of new products, marketing, advertising and
stock levels. By utilizing the Finlay Triangle, opportunities are created for
the vendor to assist in identifying fashion trends thereby improving inventory
turnover and profitability, both for the vendor and Finlay. As a result,
management believes it capitalizes on economies of scale by centralizing certain
activities, such as vendor selection, advertising and planning, while allowing
store management the flexibility to implement merchandising programs tailored to
the host store environments and clientele.
The Finlay Triangle
[GRAPHIC OMITTED]
Finlay has structured its relationships with vendors to encourage sharing
of responsibility for marketing and merchandise management. Finlay furnishes to
vendors, through on-line access to Finlay's information systems, the same sales,
stock and gross margin information that is available to Finlay's store group
management and central office for each of the vendor's styles in Finlay's
merchandise assortment. Using this information, vendors are able to participate
in decisions to replenish inventory which has been sold and to return or
exchange slower-moving merchandise. New items are tested in specially selected
"predictor" Departments where sales experience can indicate an item's future
performance in Finlay's other Departments. Management believes that the access
and input which vendors have in the
6
merchandising process results in a better assortment, timely replenishment,
higher turnover and higher sales of inventory, differentiating Finlay from its
competitors.
Since many of the host store groups in which Finlay operates differ in
fashion image and customer demographics, Finlay's flexible approach to
merchandising is designed to complement each host store's own merchandising
philosophy. Finlay emphasizes a "fashion accessory" approach to fine jewelry and
watches, and seeks to provide items that coordinate with the host store's
fashion focus as well as to maintain stocks of traditional and gift merchandise.
Store Relationships
Host Store Relationships. As of January 29, 2000, Finlay operated 987
locations (including eight stand-alone stores) in 24 host store groups, in 44
states and the District of Columbia. By acquiring Diamond Park in 1997, Finlay
added 139 Departments in three host store groups, in 19 states. By acquiring
J.B. Rudolph in April 2000, Finlay added 57 Departments in three host store
groups, in 14 states. Finlay's largest host store relationship is with May, for
which Finlay has operated Departments since 1948. Finlay operates the fine
jewelry departments in all of May's 406 department stores. Finlay's second
largest host store relationship is with Federated, for which Finlay has operated
Departments since 1983. Finlay operates Departments in 155 of Federated's 403
department stores. Over the past three years, store groups owned by May and
Federated accounted for an average of 48% and 22%, respectively, of Finlay's
domestic sales.
Finlay also operates in 144 Departments in store groups owned by Saks
Incorporated. Additionally, Finlay operates in several other host store groups,
such as Belk, The Bon-Ton and Gottschalks. Management believes that it maintains
excellent relations with its host store groups, 20 of which have had leases with
Finlay for more than five years (representing 88% of Finlay's domestic sales in
1999) and 15 of which have had leases with Finlay for more than ten years
(representing 73% of Finlay's domestic sales in 1999). As a consequence of the
strong and, in many instances, long-term relationships, host store groups have
routinely renewed Finlay's lease agreements at their renewal dates. Management
believes that the majority of its lease agreements will continue to be renewed
routinely.
7
The following table identifies the host store groups in which Finlay
operated Departments at January 29, 2000, the year in which Finlay's
relationship with each host store group commenced and the number of Departments
operated by Finlay in each host store group. The table also provides similar
information regarding Finlay's stand-alone locations.
Inception of Number of
Host Store Group/Location Relationship Departments/Stores
- ------------------------- ------------ ------------------
May
Robinsons-May.................................................. 1948 55
Filene's....................................................... 1977 42
Lord & Taylor.................................................. 1978 78
Famous Barr/L.S. Ayres/Jones................................... 1979 42
Kaufmann's..................................................... 1979 50
Foley's........................................................ 1986 57
Hecht's/Strawbridge's.......................................... 1986 74
Meier & Frank.................................................. 1988 8
---
Total May Departments....................................... 406
Federated
Rich's/Lazarus/Goldsmith's..................................... 1983 67
Burdines....................................................... 1992 45
The Bon Marche................................................. 1993 20
Stern's........................................................ 1994 23
---
Total Federated Departments................................. 155
Saks Incorporated
Younkers....................................................... 1973 36
Carson Pirie Scott/Bergner's/Boston Store...................... 1977 51
Proffitt's..................................................... 1991 16
Parisian....................................................... 1997 35
Herberger's.................................................... 1999 6
---
Total Saks Incorporated Departments......................... 144
Other Departments
Gottschalks.................................................... 1969 38
Belk........................................................... 1975 59
Liberty House.................................................. 1983 12
The Bon-Ton.................................................... 1986 46
Elder Beerman.................................................. 1992 35
Dillard's...................................................... 1997 63
Marshall Field's............................................... 1997 21
---
Total Other Departments..................................... 274
----
Total Departments........................................... 979
Stand-Alone Stores
New York Jewelry Outlet........................................ 1994 8
----
Total Departments and Stand-Alone Stores.................. 987
====
The following table identifies additional host store groups in which Finlay
operated as of April 3, 2000 as a result of the J.B. Rudolph Acquisition.
Inception of Number of
Host Store Group Relationship Departments
- ---------------- ------------ -----------
Bloomingdale's................................................. 2000 23
Hudson's....................................................... 2000 21
Dayton's....................................................... 2000 13
---
Additional Departments from the J.B. Rudolph Acquisition.. 57
====
8
Terms of Lease Agreements. Finlay's lease agreements typically have an
initial term of one to five years. Finlay has, where possible, entered into
five-year lease agreements and expects to continue this practice. Finlay's lease
agreements generally contain renewal options or provisions for automatic renewal
absent prior notice of termination by either party. Lease renewals are for one
to five year periods. In exchange for the right to operate a Department within
the host store, Finlay pays each host store group a lease fee, calculated as a
percentage of sales (subject to a minimum annual fee in a limited number of
cases).
Finlay's lease agreements generally require host stores to remit sales
proceeds for each month (without regard to whether such sales were cash, store
credit or national credit card) to Finlay approximately three weeks after the
end of such month. During the months of November and December, however, most
host store groups remit to Finlay 75% of the estimated months' sales prior to or
shortly following the end of that month. Each host store group withholds from
the remittance of sales proceeds a lease fee and other expenditures, such as
advertising costs, which the host store group may have incurred on Finlay's
behalf.
Finlay is usually responsible for providing and maintaining any fixtures
and other equipment necessary to operate its Departments, while the host store
is typically required to provide clean space for installation of any necessary
fixtures. The host store is generally responsible for paying utility costs
(except certain telephone charges), maintenance and certain other expenses
associated with the operation of the Departments. Finlay's lease agreements
typically provide that Finlay is responsible for the hiring (subject to the
suitability of such employees to the host store) and discharge of its sales and
Department supervisory personnel, and substantially all lease agreements require
Finlay to provide its employees with salaries and certain benefits comparable to
those received by the host store's employees. Many of Finlay's lease agreements
provide that Finlay may operate the Departments in any new stores opened by the
host store group. In certain instances, Finlay is operating Departments without
written agreements, although the arrangements in respect of such Departments are
generally in accordance with the terms described herein.
In many cases, Finlay is subject to limitations under its lease agreements
which prohibit Finlay from operating Departments for competing host store groups
within a certain geographical radius of the host stores (typically five to ten
miles). Such limitations restrict Finlay from further expansion within areas
where it currently operates Departments, including expansion by possible
acquisitions. Certain domestic lease agreements, however, make an exception for
adding Departments in stores established by groups with which Finlay has a
preexisting lease arrangement. In addition, Finlay has from time to time
obtained the consent of an existing host store group to operate in another host
store group within a prohibited area. For example, May and Federated have
granted consents of this type to Finlay with respect to one another's stores.
Further, Finlay sought and received the consent of certain of its existing host
store groups in connection with the Diamond Park Acquisition. In certain cases,
Finlay has found that, notwithstanding the absence of any geographical
limitation in a lease agreement, it may be limited as a practical matter from
opening Departments for competing host store groups in close proximity to each
other because of the adverse effect such openings might have on its overall host
store group relationships.
Credit. Substantially all consumer credit risk is borne by the host store
rather than by Finlay. Purchasers of Finlay's merchandise at a host store are
entitled to the use of the host store's credit facilities on the same basis as
all of the host store's customers. Payment of credit card or check transactions
is generally guaranteed to Finlay by the host store, provided that the proper
credit approvals have been obtained in accordance with the host store's policy.
Accordingly, payment to Finlay in respect of its sales proceeds is generally not
dependent on when, or if, payment is received by the host store.
9
Departments Opened/Closed. During 1999, Department openings offset by
closings, on a domestic basis, resulted in a net increase of 28 Departments. All
61 openings were within existing store groups, with the exception of six
Departments in Herberger's. The closings included 14 Departments in Crowley's
and Steinbach due to the bankruptcy of the host store, one of the Company's
outlet stores and 18 Departments closed within existing store groups. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--1999 Compared with 1998".
The following table sets forth data regarding the number of domestic
Departments and stand-alone stores which Finlay has operated from the beginning
of 1995:
Fiscal Year Ended
------------------------------------------------------------
Feb. 3, Feb. 1, Jan. 31, Jan. 30, Jan. 29,
1996 1997 1998 1999 2000
-------- -------- --------- -------- ---------
Departments/Stores:
Open at beginning of period.................... 799 834 797 959 959
Opened during period........................... 66 47 172 68 61
Closed during period........................... (31) (84) (10) (68) (33)
-------- -------- --------- -------- ---------
Open at end of period.......................... 834 797 959 959 987
-------- -------- --------- -------- ---------
Net increase (decrease)........................ 35 (37) 162 - 28
======== ======== ========= ======== =========
For the periods presented in the table above, domestic Department closings
were primarily attributable to: ownership changes in host store groups; the
bankruptcy of certain host store groups; internal consolidation within May; the
closing or sale by host store groups of individual stores; the closing of
Departments in a host store group as a result of the opening of Departments in
another host store group that competes in the same geographic market; host store
group decisions to consolidate with one lessee; and Finlay's decision to close
unprofitable Departments. To management's knowledge, none of the domestic
Department closings during the periods presented in the table above resulted
from dissatisfaction of a host store group with Finlay's performance.
Products and Pricing
Each of Finlay's Departments offers a broad selection of necklaces,
earrings, bracelets, rings and watches. Other than watches, substantially all of
the fine jewelry items sold by Finlay are made from precious metals and many
also contain diamonds or colored gemstones. Finlay also provides jewelry and
watch repair services. Finlay does not carry costume or gold-filled jewelry.
Specific brand identification is generally not important within the fine jewelry
business, except for watches and designer jewelry. With respect to watches,
Finlay emphasizes brand name vendors, including Seiko, Citizen, Movado and
Bulova. Many of Finlay's lease agreements with host store groups restrict Finlay
from selling certain types of merchandise or, in some cases, selling particular
merchandise below certain price points.
10
The following table sets forth the domestic sales and percentage of sales
by category of merchandise for 1997, 1998 and 1999:
Fiscal Year Ended
--------------------------------------------------------------------------------------
Jan. 31, 1998 Jan. 30, 1999 Jan. 29, 2000
--------------------------- ------------------------ ---------------------------
% of % of % of
Sales Sales Sales Sales Sales Sales
----------- ---------- ---------- ---------- ---------- ------------
(Dollars in millions)
Diamonds.................. $ 147.7 20.5% $ 192.0 23.4% $ 219.1 24.7%
Gemstones................. 169.0 23.4 184.4 22.4 194.5 22.0
Gold...................... 155.1 21.6 182.0 22.1 193.1 21.8
Watches................... 126.3 17.6 147.0 17.9 151.7 17.1
Other (1)................. 121.5 16.9 116.6 14.2 127.8 14.4
----------- ---------- ---------- ---------- ---------- ------------
Total Sales............... $ 719.6 100.0% $ 822.0 100.0% $ 886.2 100.0%
=========== ========== ========== ========== ========== ============
- --------------------------------
(1) Includes special promotional items, remounts, estate jewelry, pearls,
beads, cubic zirconia, sterling silver and men's jewelry, as well as repair
services and accommodation sales to Finlay employees.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
Finlay sells its merchandise at prices generally ranging from $50 to
$1,000. In 1999, the average price of items sold in the United States by Finlay
was approximately $170 per item. An average Department has over 4,000 items in
stock. Consistent with fine jewelry retailing in general, a substantial portion
of Finlay's sales are made at prices discounted from listed retail prices.
Finlay's advertising and promotional planning are closely coordinated with its
pricing strategy. Publicized sales events are an important part of Finlay's
marketing efforts. A substantial portion of Finlay's sales occur during such
promotional events. The amount of time during which merchandise may be offered
at discount prices is limited by applicable laws and regulations. See "Legal
Proceedings".
Purchasing and Inventory
General. A key element of Finlay's strategy has been to lower the working
capital investment required for operating its existing Departments and opening
new Departments. At any one time, Finlay typically is required to pay in advance
of sale for less than half of its inventory because in recent years, on average,
approximately 50% of Finlay's domestic merchandise has been obtained on
consignment and certain additional inventory has been purchased with extended
payment terms. In 1999, Finlay's net monthly investment in inventory (i.e., the
total cost of inventory owned and paid for) averaged 34% of the total cost of
its on-hand merchandise. Finlay is generally granted exchange privileges which
permit Finlay to return or exchange unsold merchandise for new products at any
time. In addition, Finlay structures its relationships with vendors to encourage
their participation in and responsibility for merchandise management. By making
the vendor a participant in Finlay's merchandising strategy, Finlay has created
opportunities for the vendor to assist in identifying fashion trends, thereby
improving inventory turnover and profitability. As a result, Finlay's direct
capital investment in inventory has been reduced to levels which it believes are
low for the retail jewelry industry. In addition, Finlay's inventory exposure to
changing fashion trends is reduced because, in general, unsold consignment
merchandise can be returned to the vendor.
Management believes the willingness of vendors to participate in the
inventory management process is due, in part, to the large volume of merchandise
which Finlay sells in its Departments and the desire of vendors to take
advantage of Finlay's nationwide distribution network. By offering their
merchandise through Finlay's Departments, vendors are able to reach a broad
spectrum of the marketplace in
11
coordination with national or regional advertising campaigns conducted by the
vendors or their service organizations.
In 1999, merchandise obtained by Finlay from its 40 largest vendors (out of
a total of approximately 325 vendors) generated approximately 76% of domestic
sales, and merchandise obtained from Finlay's largest vendor generated
approximately 11% of domestic sales. Finlay does not believe the loss of any one
of its vendors would have a material adverse effect on its business.
Gold Consignment Agreement. Finlay Jewelry is party to a gold consignment
agreement (the "Gold Consignment Agreement"), which expires on December 31,
2001. The Gold Consignment Agreement enables Finlay to receive merchandise by
providing gold, or otherwise making payment, to certain vendors who currently
supply Finlay with merchandise on consignment. While the merchandise involved
remains consigned, title to the gold content of the merchandise transfers from
the vendors to the gold consignor. Finlay can obtain, pursuant to the Gold
Consignment Agreement, up to the lesser of (i) 100,000 fine troy ounces or (ii)
$32.0 million worth of gold, subject to a formula as prescribed by the Gold
Consignment Agreement. At January 29, 2000, amounts outstanding under the Gold
Consignment Agreement totaled 77,538 fine troy ounces, valued at approximately
$22.2 million. The average amount outstanding under the Gold Consignment
Agreement was $23.5 million in 1999.
Under the Gold Consignment Agreement, Finlay is required to pay a daily
consignment fee on the dollar equivalent of the fine gold value of the ounces of
gold consigned thereunder. The daily consignment fee is based on a floating rate
which, as of January 29, 2000, was 3.75% per annum. In addition, Finlay is
required to pay a fee of 0.5% if the amount of gold consigned has a value equal
to or less than $12.0 million. In conjunction with the Gold Consignment
Agreement, Finlay granted to the gold consignor a first priority perfected lien
on, and a security interest in, specified gold jewelry of participating vendors
approved under the Gold Consignment Agreement and a lien on proceeds and
products of such jewelry subject to the terms of an intercreditor agreement
between the gold consignor and the Revolving Credit Agreement lenders.
Operations
General. Most of Finlay's Departments have between 50 and 150 linear feet
of display cases (with an average of approximately 70 linear feet) generally
located in high traffic areas on the main floor of the host stores. Each
Department is supervised by a manager whose primary duties include customer
sales and service, scheduling and training of personnel, maintaining security
controls and merchandise presentation. Most of the Departments utilize up to 260
staff hours per week on a permanent basis, depending on the Department's sales
volume, and employ additional sales staff during the peak year-end holiday
season. Each Department is open for business during the same hours as its host
store. Subject to the terms of the applicable host store group lease agreement,
Finlay is generally responsible for its own operating decisions within each of
its Department operations, including the hiring and compensation of sales staff.
See "--Store Relationships--Terms of Lease Agreements".
To parallel host store operations, Finlay establishes separate group
service organizations responsible for managing Departments operated for each
host store. Staffing for each group organization varies with the number of
Departments in each group. Typically, Finlay services each host store group with
a group manager, an assistant group manager, one or more group buyers, one or
more regional supervisors who oversee the individual Department managers and a
number of clerical employees. Each group manager reports to a regional vice
president, who is responsible for supervision of up to eight host store groups.
In its continued efforts to improve comparable Department sales through improved
operating efficiency, Finlay has taken steps to minimize administrative tasks at
the Department level, thereby improving
12
customer service and, as a result, sales. For example, Finlay implemented an
interface between store cash registers and Finlay's central office, which has
reduced administrative time.
Finlay had average domestic sales per linear foot of approximately $12,100
in 1997, $12,200 in 1998 and $12,700 in 1999. Finlay determines average sales
per linear foot by dividing its sales by the aggregate estimated measurements of
the outer perimeters of the display cases of Finlay's Departments. Finlay had
average domestic sales per Department of approximately $820,000, $857,000 and
$911,000 in 1997, 1998 and 1999, respectively.
Management Information and Inventory Control Systems. Finlay and its
vendors use the Company's management information systems to monitor sales, gross
margin and inventory performance by location, merchandise category, style number
and vendor. Using this information, Finlay is able to monitor merchandise trends
and variances in performance and improve the efficiency of its inventory
management. Finlay also measures the productivity of its sales force by
maintaining current statistics for each employee such as sales per hour,
transactions per hour and transaction size.
Personnel and Training. Finlay considers its employees an important
component of its operations and devotes substantial resources to training and
improving the quality of sales and management personnel. Finlay seeks to
motivate its employees by linking a substantial percentage of their compensation
to performance standards. In most cases, individual sales personnel are
compensated on an hourly basis and paid a commission on sales. Department
managers are generally compensated on the basis of a salary plus a percentage of
their Department's sales. Group managers and regional vice presidents are
eligible to earn bonuses of up to 50% of their base salaries upon the
achievement of specified goals.
As of the end of 1999, Finlay employed approximately 8,700 persons in the
United States, approximately 90% of whom were regional and local sales and
supervisory personnel and the balance of whom were employed in administrative or
executive capacities. Of Finlay's 8,700 employees, approximately 3,800 were
part-time employees, working less than 32 hours per week. Finlay's labor
requirements fluctuate because of the seasonal nature of Finlay's business. See
"--Seasonality". Management believes that its relations with its employees are
good. Less than 1% of Finlay's employees are unionized.
Advertising. Finlay promotes its products through four-color direct mail
catalogs, using targeted mailing lists, and newspaper advertising of the host
store groups. Finlay maintains an in-house advertising staff responsible for
preparing a majority of Finlay's advertisements and for coordinating the
finished advertisements with the promotional activities of the host stores.
Finlay's gross advertising expenditures over the past five fiscal years have
consistently been in excess of 6% of sales, a level which is consistent with the
jewelry industry's reliance on promotional efforts to generate sales. The
majority of Finlay's lease agreements with host store groups require Finlay to
expend certain specified minimum percentages of the respective Department's
annual sales on advertising and promotional activities.
Inventory Loss Prevention and Insurance. Finlay undertakes substantial
efforts to safeguard its merchandise from loss or theft, including the
installation of safes at each location and the taking of a daily diamond
inventory. During 1999, inventory shrinkage amounted to approximately 1.0% of
sales. Finlay maintains insurance covering the risk of loss of merchandise in
transit or on Finlay's premises (whether owned or on consignment) in amounts
that management believes are reasonable and adequate for the types and amounts
of merchandise carried by Finlay.
13
Gold Hedging. The cost to Finlay of gold merchandise sold on consignment in
some cases is not fixed until the sale is reported to the vendor or the gold
consignor in the case of merchandise sold pursuant to the Gold Consignment
Agreement. In such cases, the cost of merchandise varies with the price of gold
and Finlay is exposed to the risk of fluctuations in the price of gold between
the time Finlay establishes the advertised or other retail price of a particular
item of merchandise and the date on which the sale of the item is reported to
the vendor. In order to hedge against this risk and to enable Finlay to
determine the cost of such goods prior to their sale, Finlay may elect to fix
the price of gold prior to the sale of such merchandise. Accordingly, Finlay at
times enters into futures contracts, such as options or forwards or a
combination thereof. The value of gold hedged under such contracts represented
less than 3% of the Company's cost of goods sold in 1999. Under such contracts,
the Company obtains the right to purchase a fixed number of troy ounces of gold
at a specified price per ounce for a specified period. Such contracts typically
have durations ranging from one to nine months and are generally priced at the
spot gold price plus an amount based on prevailing interest rates plus customary
transactions costs. When sales of such merchandise are reported to the
consignment vendors and the cost of such merchandise becomes fixed, Finlay sells
its related hedge position. At January 29, 2000, the Company had two open
positions in futures contracts, for gold totaling 25,000 fine troy ounces,
valued at $7.3 million, which expire during the first quarter of 2000. The fair
market value of such contracts was $7.4 million at January 29, 2000.
The primary effect on liquidity from using futures contracts is associated
with the related margin requirements. Historically, cash flows related to
futures margin requirements have not been material to Finlay's total working
capital requirements. Finlay manages the purchase of futures contracts by
estimating and monitoring the quantity of gold that it anticipates it will
require in connection with its anticipated level of sales of the type described
above. Finlay's gold hedging transactions are entered into by Finlay in the
ordinary course of its business. Finlay's gold hedging strategies are determined
and monitored on a regular basis by Finlay's senior management and its Board of
Directors.
Competition
Finlay faces competition for retail jewelry sales from national and
regional jewelry chains, other department stores, local independently owned
jewelry stores and chains, specialty stores, mass merchandisers, catalog
showrooms, discounters, direct mail suppliers, televised home shopping and the
internet. Management believes that competition in the retail jewelry industry is
based primarily on the price, quality, fashion appeal and perceived value of the
product offered and on the reputation, integrity and service of the retailer.
See "--Store Relationships--Terms of Lease Agreements" with respect to certain
limitations on Finlay's ability to compete.
Seasonality
The retail jewelry business is highly seasonal. See "Selected Consolidated
Financial Data" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations-- Seasonality".
14
Item 2. Properties
The only real estate owned by Finlay is the central distribution facility,
totaling 106,200 square feet at 205 Edison Avenue, Orange, Connecticut. Finlay
leases approximately 18,400 square feet at 521 Fifth Avenue, New York, New York,
and 49,100 square feet at 529 Fifth Avenue, New York, New York for its
executive, accounting, advertising, the majority of its data processing
operations and other administrative functions. The leases for such space expire
September 30, 2008. The Company leases an additional 2,140 square feet at 521
Fifth Avenue, New York, New York under a lease which expires March 31, 2001. For
certain operations at 500 Eighth Avenue, New York, New York and 500 Fifth
Avenue, New York, New York, Finlay has leased approximately 9,200 square feet
under a lease which expires January 31, 2001 and approximately 3,600 square feet
under a lease which expires July 31, 2000, respectively. Finlay also leases
retail space for its New York Jewelry Outlet stores. Generally, as part of
Finlay's lease arrangements, host stores provide office space to Finlay's host
store group management personnel free of charge.
Item 3. Legal Proceedings
Finlay is involved in certain legal actions arising in the ordinary course
of business. Management believes none of these actions, either individually or
in the aggregate, will have a material adverse effect on Finlay's business,
financial position or results of operations.
Commonly in the retail jewelry industry, a substantial amount of
merchandise is sold at a discount to the "regular" or "original" price. Finlay's
experience is consistent with this practice. See "Business-- Products and
Pricing". A number of states in which Finlay operates have regulations which
require retailers who offer merchandise at discounted prices to offer the
merchandise at the "regular" or "original" prices for stated periods of time.
Management believes it is in substantial compliance with all applicable legal
requirements with respect to such practices.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of 1999.
15
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The Common Stock of the Company is traded on the Nasdaq National Market
under the symbol "FNLY". The high and low sales prices for the Common Stock
during 1998 and 1999 were as follows:
Fiscal Year Ended
---------------------------------------------------
January 30, 1999 January 29, 2000
---------------------- ------------------------
High Low High Low
--------- --------- ----------- ---------
First Quarter................................. $ 28-7/8 $ 23 $ 11-3/16 $ 8-1/4
Second Quarter................................ 27-3/8 21-3/4 14-9/16 10-5/16
Third Quarter................................. 23-3/8 4-5/8 14-1/2 11-7/8
Fourth Quarter................................ 12 7 141-5/16 11-1/2
The Company has never paid cash dividends on its Common Stock and has no
present intention to pay any cash dividends in the foreseeable future. Certain
restrictive covenants in the indentures relating to the Senior Notes (the
"Senior Note Indenture"), the Senior Debentures (the "Senior Debenture
Indenture", and collectively the "Senior Indentures"), the Revolving Credit
Agreement and the Gold Consignment Agreement impose limitations on the payment
of dividends by the Company (including Finlay Jewelry's ability to pay dividends
to the Company).
During 1999, cash dividends of $7.2 million were distributed by Finlay
Jewelry to the Company. The distributions are generally utilized to pay interest
on the Senior Debentures and certain expenses of the Company such as legal,
accounting and directors' fees.
As of April 24, 2000, there were 10,421,353 shares of Common Stock
outstanding and approximately 62 record holders of the Common Stock, including
holders who are nominees for an undetermined number of beneficial owners,
estimated to be in excess of 500. The last reported sale price for the Common
Stock on the Nasdaq National Market on April 24, 2000 was $10.50.
16
Item 6. Selected Consolidated Financial Data
The selected consolidated financial information below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and Notes
thereto. See "Index to Consolidated Financial Statements". The balance sheet
data of the Company at January 30, 1999 and January 29, 2000 and the statement
of operations data for each of the fiscal years ended January 31, 1998, January
30, 1999 and January 29, 2000 were derived from consolidated financial
statements of the Company, which statements have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their report included
elsewhere herein. The balance sheet data of the Company at February 3, 1996,
February 1, 1997 and January 31, 1998 and the statement of operations data for
the fiscal years ended February 3, 1996 and February 1, 1997 were derived from
consolidated financial statements of the Company, which statements have been
audited by Arthur Andersen LLP, independent public accountants, and which are
not included or incorporated herein.
Fiscal Year Ended (1)
--------------------------------------------------------------------------
Feb. 3, Feb. 1, Jan. 31, Jan. 30, Jan. 29,
1996 1997 1998 1999 2000
------------ ---------- ---------- ---------- --------------
(Dollars in thousands, except per share data)
Statement of Operations Data:
Sales........................................... $ 654,491 $ 685,274 $ 769,862 $ 863,428 $ 912,978
Cost of sales................................... 314,029 330,300 371,085 421,450 449,912
Cost of sales - Sonab inventory write-down (2).. - - - - 7,839
------------ ---------- ---------- ---------- --------------
Gross margin (3)................................ 340,462 354,974 398,777 441,978 455,227
Selling, general and administrative expenses.... 282,504 290,138 324,777 364,652 379,083
Nonrecurring charges associated with the sale
and closure of Sonab (2)...................... - - - - 20,792
Depreciation and amortization................... 9,659 10,840 12,163 15,672 16,895
------------ ---------- ---------- ---------- --------------
Income (loss) from operations................... 48,299 53,996 61,837 61,654 38,457
Other nonrecurring income (4)................... (5,000) - - - -
Interest expense, net........................... 29,705 31,204 34,115 32,499 29,505
Nonrecurring interest associated with
refinancing (5)............................... - - - 655 -
------------ ---------- ---------- ---------- --------------
Income (loss) before income taxes and
extraordinary charges........................ 23,594 22,792 27,722 28,500 8,952
Provision (benefit) for income taxes............ 9,343 11,035 12,527 11,986 4,889
------------ ---------- ---------- ---------- --------------
Income (loss) before extraordinary charges...... 14,251 11,757 15,195 16,514 4,063
Extraordinary charges from early extinguishment
of debt, net (6)............................. - - - 7,415 -
------------ ---------- ---------- ---------- --------------
Net income (loss)............................... $ 14,251 $ 11,757 $ 15,195 $ 9,099 $ 4,063
============ ========== ========== ========== ==============
Net income (loss) applicable to common shares... $ 3,534 $ 11,757 $ 15,195 $ 9,099 $ 4,063
Net income (loss) per share applicable to
common shares:
Basic net income (loss) per share:
Before extraordinary charges................ $ 0.55 $ 1.59 $ 1.89 $ 1.61 $ 0.39
Extraordinary charges from early
extinguishment of debt................... $ - $ - $ - $ (0.72) $ -
Net income (loss)........................... $ 0.55 $ 1.59 $ 1.89 $ 0.89 $ 0.39
Diluted net income (loss) per share:
Before extraordinary charges................ $ 0.53 $ 1.55 $ 1.84 $ 1.59 $ 0.39
Extraordinary charges from early
extinguishment of debt................... $ - $ - $ - $ (0.72) $ -
Net income (loss)........................... $ 0.53 $ 1.55 $ 1.84 $ 0.88 $ 0.39
Weighted average number of shares and share
equivalents outstanding (000's)............... 6,640 7,570 8,276 10,366 10,504
17
Fiscal Year Ended (1)
--------------------------------------------------------------------------
Feb. 3, Feb. 1, Jan. 31, Jan. 30, Jan. 29,
1996 1997 1998 1999 2000
----------- ----------- ------------ ------------ -----------
(Dollars in thousands, except per share data)
Pro Forma Consolidated Statement of Operations Data (7):
Net income (loss) .............................. $ 9,725 $ 16,914 $ 21,099
Net income (loss) per share applicable to
common shares:
Basic net income (loss) per share............. $ 1.32 $ 1.65 $ 2.03
Diluted net income (loss) per share........... $ 1.29 $ 1.63 $ 2.01
Pro Forma Domestic Statement of Operations Data (8):
Sales........................................... $ 607,701 $ 634,922 $ 719,607 $ 822,035 $ 886,223
EBITDA (12)..................................... $ 52,329 $ 58,790 $ 68,825 $ 77,123 $ 87,159
Net income (loss) .............................. $ 7,811 $ 9,789 $ 14,123 $ 18,850 $ 24,616
Net income (loss) per share applicable to
common shares:
Basic net income (loss) per share............. $ 1.06 $ 1.32 $ 1.75 $ 1.84 $ 2.36
Diluted net income (loss) per share........... $ 1.03 $ 1.29 $ 1.71 $ 1.82 $ 2.34
Operating and Financial Data:
Number of Departments (end of period) (9):
Consolidated................................... 941 939 1,117 1,109 987
Domestic....................................... 834 797 959 959 987
Percentage increase in sales..................... 18.5% 4.7% 12.3% 12.2% 5.7%
Percentage increase in comparable Department
sales (9)(10):
Consolidated................................... 5.7% 5.9% 5.5% 3.9% 6.8%
Domestic....................................... 5.5% 6.0% 5.7% 5.4% 8.1%
Average domestic sales per Department (11)....... $ 744 $ 779 $ 820 $ 857 $ 911
EBITDA (12)...................................... 57,958 64,836 74,000 77,326 55,352
Capital expenditures............................. 14,933 17,533 19,338 14,874 14,972
Cash flows provided from (used in):
Operating activities............................. $ (5,302) $ 13,071 $ 35,910 $ 23,121 $ 38,804
Investing activities............................. (16,515) (18,154) (78,915) (23,134) (21,054)
Financing activities............................. 24,444 61 36,083 3,692 137
Balance Sheet Data-End of Period:
Working capital.................................. $ 66,395 $ 77,616 $ 108,395 $ 147,337 $ 157,587
Total assets..................................... 395,145 421,273 508,236 543,992 557,042
Short-term debt, including current portion of
long-term debt................................. 206 2 - - -
Long-term debt, excluding current portion........ 202,905 211,427 221,026 225,000 225,000
Total stockholders' equity (deficit)............. 12,784 22,505 72,339 99,811 108,800
- ----------------------------
(1) Each of the fiscal years for which information is presented includes 52
weeks except 1995, which includes 53 weeks.
(2) Included in 1999 are nonrecurring charges associated with the sale and
closure of Sonab totaling $28.6 million. Included in cost of sales is $7.8
million for the write-down of inventory with the balance of $20.8 million
recorded as an operating expense. Refer to Note 14 of Notes to Consolidated
Financial Statements.
(3) Finlay utilizes the LIFO method of accounting for inventories. If Finlay
had valued inventories at actual cost, as would have resulted from the
specific identification inventory valuation method, the gross margin would
have increased (decreased) as follows: $0.9 million, $1.9 million, $(2.3)
million, $(1.0) million and $(1.1) million for 1995, 1996, 1997, 1998 and
1999, respectively.
(4) Included in 1995 are proceeds of $5.0 million from a life insurance policy
Finlay maintained on a senior executive.
(5) As a result of certain call requirements associated with the Old Debentures
and the Old Notes, Finlay had outstanding both the new debt and the old
debt for a period of twenty-five days in 1998. The net effect of the above,
offset by reduced
(Footnotes continued on following page)
18
interest expense on the borrowings under the Revolving Credit Agreement and
interest income on excess cash balances, was $0.7 million.
(6) The extraordinary charges of $12.2 million include $7.1 million for
redemption premiums on the Old Debentures and the Old Notes and $3.9
million to write off deferred financing costs and debt discount associated
with the Old Debentures and the Old Notes. The income tax benefit on the
extraordinary charges totaled $4.8 million.
(7) The pro forma financial information for 1995 gives effect to the Company's
April 1995 initial public offering of 2.5 million shares (the "Initial
Public Offering"), at a price of $14.00 per share, and related transactions
as if such transactions had occurred at the beginning of 1995. The pro
forma financial information excludes proceeds of $5.0 million from a life
insurance policy Finlay maintained on a senior executive. Net income (loss)
was derived by adjusting the historical amounts to reflect interest expense
on the adjusted debt structure and the elimination of the life insurance
proceeds and the related income tax effects thereon. The pro forma
financial information for 1998 excludes (i) the extraordinary charge of
$12.2 million, on a pre-tax basis, described in Note 6 above, and (ii) the
nonrecurring interest associated with refinancing, described in Note 5
above. The pro forma financial information for 1999 excludes the effect of
the nonrecurring charges associated with the sale and closure of Sonab
totaling $28.6 million on a pre-tax basis. Refer to Notes 12 and 14 of
Notes to Consolidated Financial Statements.
(8) The pro forma financial information reflects the Company's domestic
operations only and excludes the operations of Sonab, as well as the impact
of the sale and closure of Sonab. Refer to Note 13 of Notes to Consolidated
Financial Statements. For 1995 and 1998, refer to Note 7 above for
additional pro forma adjustments.
(9) Includes Departments and stand-alone locations.
(10) Comparable Department sales are calculated by comparing the sales from
Departments open for the same months in the comparable periods.
(11) Average domestic sales per Department is determined by dividing domestic
sales by the average of the number of domestic Departments open at the
beginning and at the end of each period.
(12) EBITDA represents income from operations before depreciation and
amortization expenses. For 1999, consolidated EBITDA includes the
nonrecurring charge totaling $28.6 million associated with the sale and
closure of Sonab. The Company believes EBITDA provides additional
information for determining its ability to meet future debt service
requirements. EBITDA should not be construed as a substitute for income
from operations, net income or cash flow from operating activities (all as
determined in accordance with generally accepted accounting principles) for
the purpose of analyzing Finlay's operating performance, financial position
and cash flows as EBITDA is not defined by generally accepted accounting
principles. Finlay has presented EBITDA, however, because it is commonly
used by certain investors and analysts to analyze and compare companies on
the basis of operating performance and to determine a company's ability to
service and/or incur debt. Finlay's computation of EBITDA may not be
comparable to similar titled measures of other companies.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following should be read in conjunction with "Selected Consolidated
Financial Information" and the Consolidated Financial Statements and Notes
thereto included elsewhere in this Form 10-K.
Certain statements under this caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations" constitute "forward-looking
statements" under the Securities Act of 1933, as amended (the "Securities Act"),
and the Securities Exchange Act of 1934, as amended (the "Exchange Act"). See
"Special Note Regarding Forward-Looking Statements".
General
Since 1997, sales have increased by $143.1 million to $913.0 million, a
compound annual growth rate of 8.9%, while comparable Department sales have
increased by 5.5%, 3.9% and 6.8% in 1997, 1998 and 1999, respectively.
Comparable Department sales include Departments open for the same months during
comparable periods. Domestic comparable Department sales during this same period
increased 5.7%, 5.4% and 8.1%. The increase in total sales during this period is
the result of (i) adding new Departments, including 139 Departments from the
Diamond Park Acquisition, and (ii) increasing comparable Department sales.
Management attributes its comparable Department sales increases during this
period to continued focus on the following Company initiatives: (i) emphasizing
its "Key Item" and "Best Value" merchandising programs, which provide a targeted
assortment of items at competitive prices; (ii) increasing focus on holiday and
event-driven promotions as well as host store marketing programs; (iii)
positioning the Company's Departments as a "destination location" for fine
jewelry; and 19
(iv) refinement of project PRISM (Promptly Reduce Inefficiencies and Sales
Multiply), a program designed to allow Finlay's sales associates more time for
customer sales and service.
Finlay entered the international fine jewelry retailing market in October
1994 by acquiring Sonab. In the second quarter of 1998, Sonab began to
experience lower sales trends due to the transition from a promotional pricing
strategy to an everyday low price strategy. The adverse impact of such change
continued throughout 1999. As a result of the foregoing, on January 3, 2000,
Sonab sold the majority of its assets for $9.9 million. After the sale, the
buyer operated more than 80 locations previously included in Sonab's
130-location base in France. The remaining departments were closed. The Company
recorded a pre-tax charge of $28.6 million for the write-down of assets for
disposition and related closure expenses in 1999, of which $7.8 million was
recorded as a component of cost of sales as it related specifically to the
write-down of inventory, with the balance of $20.8 million recorded as an
operating expense.
Gross margin as a percentage of sales has decreased from 51.8% in 1997 to
49.9% in 1999. This decrease is principally the result of the Sonab cost of
sales charge of $7.8 million in 1999, the Company's "Key Item" and "Best Value"
programs, which produce higher sales volume and a slightly lower gross margin,
on average, than other merchandise, the integration of the former Diamond Park
Departments at a lower gross margin and the lower benefit of the LIFO method of
inventory in 1999 compared to 1997.
Selling, general and administrative expenses ("SG&A") as a percentage of
sales have decreased from 42.2% in 1997 to 41.5% in 1999. Management attributes
this improvement to (i) leveraging operating expenses through higher domestic
sales, (ii) reducing the level of certain operating expenses through the ongoing
implementation of project PRISM, (iii) reducing payroll expense, as a percentage
of sales, which reflects management's continued initiatives in controlling
payroll hours and labor rates and (iv) the full year impact of the operation of
the central distribution center in consolidating the inventory processing
function. In 1999, the favorable SG&A improvement was offset by expenses
associated with the Company's year 2000 remediation project. In addition, the
leveraging of operating expenses was negatively impacted as a result of the
slowdown of sales in France in 1999. The components of SG&A include payroll
expense, lease fees, net advertising expenditures and other field and
administrative expenses.
As a result of a series of recapitalizaton transactions in 1993 (the "1993
Recapitalization") and a 1988 reorganization transaction involving Finlay
Jewelry (the "1988 Leveraged Recapitalization"), the Company is highly leveraged
and, as such, interest expense had a significant impact on the Company's results
of operations. The Refinancing resulted in lower interest rates on the Senior
Debentures and the Senior Notes than the interest rates on the Old Debentures
and the Old Notes. As such, for 1999, interest expense has been favorably
impacted as compared to 1997. The Company also records approximately $3.6
million of goodwill amortization annually resulting primarily from the 1988
Leveraged Recapitalization and the Diamond Park Acquisition.
On October 6, 1997, Finlay completed the acquisition of certain assets of
Diamond Park, a leading operator of Departments, for approximately $63.0
million. By acquiring Diamond Park, Finlay added 139 Departments and also added
new host store relationships with Marshall Field's, Parisian and Dillard's
(formerly the Mercantile Stores).
20
Results of Operations
The following table sets forth operating results as a percentage of sales
for the periods indicated:
Fiscal Year Ended
------------------------------------------------
Jan. 31, Jan. 30, Jan. 29,
1998 1999 2000
------------ ------------- ------------
Statement of Operations Data:
Sales.................................................... 100.0% 100.0% 100.0%
Cost of sales............................................ 48.2 48.8 49.3
Cost of sales - Sonab inventory write-down (1)........... - - 0.8
------------ ------------- ------------
Gross margin........................................... 51.8 51.2 49.9
Selling, general and administrative expenses............. 42.2 42.2 41.5
Nonrecurring charges associated with the sale
and closure of Sonab (1).............................. - - 2.3
Depreciation and amortization............................ 1.6 1.8 1.9
------------ ------------- ------------
Income (loss) from operations............................ 8.0 7.2 4.2
Interest expense, net.................................... 4.4 3.8 3.2
Nonrecurring interest associated with refinancing (2) - 0.1 -
------------ ------------- ------------
Income (loss) before income taxes and extraordinary charges
3.6 3.3 1.0
Provision for income taxes............................... 1.6 1.4 0.5
------------ ------------- ------------
Income (loss) before extraordinary charges.............. 2.0 1.9 0.5
Extraordinary charges from early extinquishment
of debt, net (3) - 0.8 -
------------ ------------- ------------
Net income (loss)........................................ 2.0% 1.1% 0.5%
============ ============= ============
Other Supplemental Data:
EBITDA (4)(5)............................................ 9.6% 9.0% 6.1%
- ----------------------
(1) See Note 2 to "Selected Consolidated Financial Data".
(2) See Note 5 to "Selected Consolidated Financial Data".
(3) See Note 6 to "Selected Consolidated Financial Data".
(4) EBITDA represents income from operations before depreciation and
amortization expenses. The Company believes EBITDA provides additional
information for determining its ability to meet future debt service
requirements. See Note 12 to "Selected Consolidated Financial Data".
(5) For 1999, EBITDA as a percentage of sales includes the nonrecurring charges
associated with the sale and closure of Sonab. Excluding these charges,
EBITDA as a percentage of sales was 9.2%.
1999 Compared with 1998
Sales. Sales increased $49.6 million, or 5.7%, in 1999 compared to 1998.
Comparable Department sales increased 6.8%. Domestic comparable Department sales
increased 8.1%. Management attributes this increase in comparable Department
sales primarily to the "Key Item" and "Best Value" merchandising programs and to
the marketing initiatives discussed above. Total consolidated sales were
negatively impacted by $9.2 million primarily relating to Dillard's purchase of
the Mercantile Stores in the fall of 1998 and its change to an everyday low
price strategy as well as the net effect of new store openings offset by store
closings.
21
During 1999, Finlay opened 61 Departments and closed 183 Departments. The
Department openings were comprised of the following:
Number of
Departments/
Store Group Stores Reason
----------------------------------- ------------- -----------------------------------------------------------
Herberger's..................... 6 New host store.
Other........................... 55 Department openings within existing store groups.
---
61
===
The Department closings were comprised of the following:
Number of
Departments/
Store Group Stores Reason
----------------------------------- ------------- -----------------------------------------------------------
All Sonab host stores........... 150 130 closings due to the sale and closure of Sonab's
operations.
Crowley's/Steinbach............. 14 Bankruptcy of the host store.
New York Jewelry Outlet......... 1 Closed upon lease expiration.
Other........................... 18 Department closings within existing store groups.
---
183
===
Gross margin. Gross margin increased by $13.2 million in 1999 compared to
1998, however, as a percentage of sales, gross margin decreased by 1.3%,
primarily due to (i) a nonrecurring charge of $7.8 million relating to the
write-down of inventory in conjunction with the sale and closure of Sonab's
operations and (ii) management's efforts to increase market penetration and
market share through its pricing strategy. The Company benefited from a decrease
in the LIFO provision of approximately $1.0 million in each 1999 and 1998.
Selling, general and administrative expenses. SG&A totaled $379.1 million,
an increase of $14.4 million, or 4.0%, in 1999 compared to 1998 due primarily to
payroll expense and lease fees associated with the increase in the Company's
sales. SG&A as a percentage of sales decreased to 41.5% in 1999 from 42.2% in
1998 as a result of the Company's strong domestic comparable Department sales,
which enabled the Company to leverage administrative and certain other expenses.
Also contributing to the decrease in SG&A as a percentage of sales was the
leveraging of payroll expense, reflecting management's continued initiatives in
controlling payroll hours and labor rates, and the full year impact of the
operation of the central distribution center in consolidating the inventory
processing function. SG&A as a percentage of sales was negatively impacted as a
result of the slowdown of sales in France.
Nonrecurring charges associated with the sale and closure of Sonab. As a
result of the sale of the majority of Sonab's assets and the disposition of the
remaining assets, the Company recorded a nonrecurring charge of $20.8 million.
The components of the charge relate to the realization of foreign exchange
losses, payroll and severance costs, other close-down costs and the write-off of
undepreciated assets.
Depreciation and amortization. Depreciation and amortization increased by
$1.2 million in 1999 compared to 1998, reflecting $15.0 million in capital
expenditures for the most recent twelve months, offset by the effect of certain
assets becoming fully depreciated. The increase in fixed assets was primarily
due to the addition of new Departments and the renovation of existing
Departments.
Interest expense, net. Interest expense decreased by $3.0 million
reflecting a lower weighted average interest rate (8.2% for 1999 compared to
8.6% for 1998) relating to the lower interest rates on the Senior Debentures and
the Senior Notes as compared to the Old Debentures and the Old Notes, which were
22
outstanding for a portion of the 1998 period. In addition, there was a decrease
in average borrowings ($329.2 million for 1999 compared to $352.1 million for
1998). The 1998 average borrowings were adjusted to exclude the timing impact of
the call requirements on the Old Debentures and the Old Notes, discussed below.
Nonrecurring interest associated with refinancing. As a result of certain
call requirements associated with the Old Debentures and the Old Notes, the debt
could not be repaid until May 26, 1998. Thus, for twenty-five days in 1998,
Finlay was required to maintain as outstanding both the new debt issued on April
24, 1998 as well as the old debt retired on May 26, 1998. The net effect of
carrying the new and old debt, offset by reduced interest expense on the
borrowings under the Revolving Credit Agreement and interest income on excess
cash balances, was an increase to interest expense of $0.7 million.
Provision for income taxes. The income tax provision for 1999 and 1998
reflects an effective tax rate of 40.5%.
Extraordinary charges from early extinguishment of debt, net of income tax
benefit. In conjunction with the repayment of the Old Debentures and the Old
Notes, the Company recorded a pre-tax extraordinary charge of $12.2 million in
1998, including $7.1 million for redemption premiums and $3.9 million to write
off deferred financing costs and debt discount associated with the Old
Debentures and the Old Notes. The income tax benefit on the extraordinary
charges totaled $4.8 million.
Net income. Net income of $4.1 million for 1999 represents a decrease of
$5.0 million as compared to net income of $9.1 million in 1998 as a result of
the factors discussed above. Excluding the nonrecurring and extraordinary
charges in 1999 and 1998, pro forma net income increased by $4.2 million to
$21.1 million.
1998 Compared with 1997
Sales. Sales increased $93.6 million, or 12.2%, in 1998 compared to 1997.
Comparable Department sales increased 3.9%. Domestic comparable Department sales
increased 5.4%. Management attributes this increase in comparable Department
sales primarily to the "Key Item" and "Best Value" merchandising programs and to
the marketing initiatives discussed above. Sales from the operation of net new
Departments contributed $63.5 million, primarily due to the acquisition of the
former Diamond Park Departments. This increase was offset by the net effect of
new store openings and closings as well as the timing of such Department
openings and closings.
During 1998, Finlay opened 78 Departments and closed 86 Departments. The
Department openings were comprised of the following:
Number of
Departments/
Store Group Stores Reason
----------------------------------- ------------- ------------------------------------------------------------
Proffitt's/Parisian/Younkers.... 12 Proffitt's/Parisian/Younkers' purchase from Dillard's.
Famous Barr/L.S. Ayres.......... 8 Famous Barr /L.S. Ayres' purchase from Dillard's.
Belk............................ 7 Belk's purchase from Dillard's.
Foley's......................... 1 Foley's purchase from Dillard's.
Dillard's....................... 3 Dillard's purchase from Belk.
Monoprix/Allders/Beatties....... 9 Sonab Department openings.
Other........................... 38 Department openings within existing store groups.
---
78
===
23
The Department closings were comprised of the following:
Number of
Departments/
Store Group Stores Reason
----------------------------------- ------------- --------------------------------------------------------
Mercantile Stores............... 28 Departments sold by Dillard's to existing Finlay
host store groups subsequent to Dillard's
acquisition of the Mercantile Stores. Included in
openings above.
Dillard's....................... 5 Previous Dillard's Departments prior to Dillard's
acquisition of the Mercantile Stores.
Debenhams....................... 7 Mutual agreement to close.
Monoprix........................ 9 Close smaller volume Departments.
Other........................... 37 Department closings within existing store groups.
---
86
===
Gross margin. Gross margin increased by $43.2 million in 1998 compared to
1997, however, as a percentage of sales, gross margin decreased by 0.6%,
primarily due to (i) management's efforts to increase market penetration and
market share through its pricing strategy and (ii) lower gross margins
experienced by the former Diamond Park Departments, particularly as the
merchandise acquired as part of the Diamond Park Acquisition continued to be
sold in 1998. During 1998, the Company benefited from a decrease in the LIFO
provision of $1.0 million, which was lower than the benefit in 1997 of $2.3
million.
Selling, general and administrative expenses. SG&A totaled $364.7 million,
an increase of $39.9 million, or 12.3%, in 1998 compared to 1997 due primarily
to payroll expense and lease fees associated with the increase in the Company's
sales. The increased sales generated by the former Diamond Park Departments and
strong domestic comparable Department sales enabled the Company to leverage
administrative and certain other expenses. Offsetting this were higher than
anticipated expenses relating to the central distribution facility during its
initial start up phase and expenses associated with the Company's year 2000
remediation project. In addition, the leveraging of operating expenses was
negatively impacted as a result of the slowdown of sales in France. As a result
of the factors discussed above, SG&A as a percentage of sales was unchanged
compared to 1997.
Depreciation and amortization. Depreciation and amortization increased by
$3.5 million in 1998 compared to 1997, reflecting $14.9 million in capital
expenditures for the most recent twelve months, depreciation on Finlay's central
distribution facility and amortization related to the Diamond Park Acquisition,
offset by the effect of certain assets becoming fully depreciated. The increase
in fixed assets was primarily due to the addition of new Departments and the
renovation of existing Departments.
Interest expense, net. Interest expense decreased by $1.6 million
reflecting a lower weighted average interest rate (8.6% for 1998 compared to
10.1% for 1997) relating to the lower interest rates on the Senior Debentures
and the Senior Notes as compared to the Old Debentures and the Old Notes. This
was partially offset by an increase in average borrowings ($352.1 million for
1998 compared to $324.6 million for 1997). The increase in average borrowings is
a result of an increase in the outstanding balance of the Old Debentures prior
to the redemption date, due to the accretion of interest and additional
indebtedness outstanding under the Revolving Credit Agreement (adjusted to
exclude the timing impact of the call requirements on the Old Debentures and the
Old Notes, discussed below).
Nonrecurring interest associated with refinancing. As a result of certain
call requirements associated with the Old Debentures and the Old Notes, the debt
could not be repaid until May 26, 1998. Thus, for twenty-five days, Finlay was
required to maintain as outstanding both the new debt issued on
24
April 24, 1998 as well as the old debt retired on May 26, 1998. The net effect
of carrying the new and old debt, offset by reduced interest expense on the
borrowings under the Revolving Credit Agreement and interest income on excess
cash balances, was an increase to interest expense of $0.7 million.
Provision for income taxes. The income tax provision for 1998 and 1997
reflects an effective tax rate of 40.5% and 41.5%, respectively.
Extraordinary charges from early extinguishment of debt, net of income tax
benefit. In conjunction with the repayment of the Old Debentures and the Old
Notes, the Company recorded a pre-tax extraordinary charge of $12.2 million in
1998, including $7.1 million for redemption premiums and $3.9 million to write
off deferred financing costs and debt discount associated with the Old
Debentures and the Old Notes. The income tax benefit on the extraordinary
charges totaled $4.8 million.
Net income. Net income of $9.1 million for 1998 represents a decrease of
$6.1 million as compared to net income of $15.2 million in 1997 as a result of
the factors discussed above. Income before extraordinary charges increased by
$1.3 million to $16.5 million in 1998. Excluding the nonrecurring interest and
extraordinary charges, pro forma net income increased by $1.7 million to $16.9
million.
Liquidity and Capital Resources
Finlay's primary capital requirements are for funding working capital for
new Departments and for working capital growth of existing Departments and, to a
lesser extent, capital expenditures for opening new Departments, renovating
existing Departments and information technology investments. For 1999, capital
expenditures totaled $15.0 million and in 1998 totaled $14.9 million. Total
capital expenditures for 2000 are estimated to be approximately $15.0 million,
exclusive of the fixed assets acquired in the J.B. Rudolph Acquisition. Although
capital expenditures are limited by the terms of the Revolving Credit Agreement,
to date this limitation has not precluded the Company from satisfying its
capital expenditure requirements.
Finlay's operations substantially preclude customer receivables and in
recent years, on average, approximately 50% of Finlay's domestic merchandise has
been carried on consignment. Accordingly, management believes that relatively
modest levels of working capital are required in comparison to many other
retailers. The Company's working capital balance was $157.6 million at January
29, 2000, an increase of $10.3 million from January 30, 1999. The increase
resulted primarily from the impact of 1999's net income exclusive of
depreciation and amortization partially offset by capital expenditures and
additions to deferred charges. Based on the seasonal nature of Finlay's
business, working capital requirements and therefore borrowings under the
Revolving Credit Agreement can be expected to increase on an interim basis
during the first three quarters of any given fiscal year. See "--Seasonality".
The seasonality of Finlay's business causes working capital requirements to
reach their highest level in the months of October, November and December in
anticipation of the year-end holiday season. Accordingly, Finlay experiences
seasonal cash needs as inventory levels peak. The Revolving Credit Agreement
provides Finlay with a line of credit of up to $275.0 million to finance working
capital needs. Amounts outstanding under the Revolving Credit Agreement bear
interest at a rate equal to, at Finlay's option, (i) the Index Rate (as defined
in the Revolving Credit Agreement) plus a margin ranging from zero to 1.0% or
(ii) adjusted LIBOR plus a margin ranging from 1.0% to 2.0%, in each case
depending on the financial performance of the Company.
In each year, Finlay is required to reduce the outstanding revolving credit
balance and letter of credit balance under the Revolving Credit Agreement to
$50.0 million or less and $20.0 million or less, respectively, for a 30
consecutive day period (the "Balance Reduction Requirement"). Borrowings under
25
the Revolving Credit Agreement at January 29, 2000 and January 30, 1999 were
zero. The average amounts outstanding under the Revolving Credit Agreement for
1998 and 1999 were $123.8 million (adjusted for the impact of the temporary
paydown of the revolving credit facility due to certain call requirements
associated with the Old Debentures and the Old Notes) and $104.2 million,
respectively. The maximum amount outstanding for 1999 was $158.2 million.
Finlay does not expect that significant additional working capital will be
required with respect to the operation of the former J.B. Rudolph Departments
because Finlay purchased the inventory of those J.B. Rudolph Departments which
it acquired. On a going-forward basis, Finlay expects that inventory purchases
for the former J.B. Rudolph Departments will be financed in part by trade
payables combined with the utilization of consignment inventory. Finlay financed
the J.B. Rudolph Acquisition with borrowings under its Revolving Credit
Agreement.
On January 3, 2000, Sonab sold the majority of its assets for approximately
$9.9 million. As of January 29, 2000, Sonab had received $1.2 million of the
sale proceeds. Sonab received an additional $6.8 million in February 2000 upon
the completion of the post-closing audit, and the balance of $1.9 million
remains paid subject to certain escrow arrangements among the parties. After the
sale, the buyer operated more than 80 locations previously included in Sonab's
130-location base in France. The remaining departments were closed. The Company
recorded a pre-tax charge in the fourth quarter of 1999 of $28.6 million, or
$1.62 per share on a diluted basis after-tax, for the write-down of assets for
disposition and related closure expenses. The cash portion of this charge was
approximately $7.8 million.
Finlay's long-term needs for external financing will depend on its rate of
growth, the level of internally generated funds and the ability to continue
obtaining substantial amounts of merchandise on advantageous terms, including
consignment arrangements with its vendors. As of January 29, 2000, $329.9
million of consignment merchandise from approximately 300 vendors was on hand as
compared to $283.8 million at January 30, 1999. For 1999, Finlay had an average
balance of consignment merchandise of $321.7 million as compared to an average
balance of $268.5 million in 1998. See "Business--Store Relationships" and
"Business--Purchasing and Inventory".
A substantial amount of Finlay's operating cash flow has been used or will
be required to pay, directly or indirectly, interest with respect to the Senior
Debentures, the Senior Notes and amounts due under the Revolving Credit
Agreement, including the payments required pursuant to the Balance Reduction
Requirement. As of January 29, 2000, Finlay's outstanding borrowings were $225.0
million, which included a $75.0 million balance under the Senior Debentures and
a $150.0 million balance under the Senior Notes.
Finlay Jewelry is party to the Gold Consignment Agreement, which expires on
December 31, 2001. The Gold Consignment Agreement enables Finlay Jewelry to
receive merchandise by providing gold, or otherwise making payment, to certain
vendors. Finlay Jewelry can obtain, pursuant to the Gold Consignment Agreement,
up to the lesser of (i) 100,000 fine troy ounces or (ii) $32.0 million worth of
gold, subject to a formula as prescribed by the Gold Consignment Agreement. At
January 29, 2000, amounts outstanding under the Gold Consignment Agreement
totaled 77,538 fine troy ounces, valued at approximately $22.2 million. The
average amount outstanding under the Gold Consignment Agreement was $23.5
million in 1999.
Many of Finlay's computer systems, software products, other systems using
embedded chips and third party systems, accepted only two entries in the date
field to distinguish the year. Beginning in the year 2000, these date fields
needed to accept four digit entries, or properly handle two digit entries, to
distinguish 21st century dates from 20th century dates. As a result, Finlay's
date critical functions would
26
have been adversely affected unless the computer systems and software products
of both Finlay and significant third parties were year 2000 compliant.
A comprehensive plan was prepared so that all systems critical to the
operation of the Company would be year 2000 compliant. The plan was structured
into five primary phases: identification, assessment, remediation, testing and
implementation. The Company completed all phases and implemented all remediated
applications during the third quarter of 1999. The Company continued to conduct
general systems testing as well as testing of specific year 2000 scenarios
through January 2000. In addition, the Company formally communicated with its
host stores, vendors and other third parties to determine the extent to which
the Company may have been vulnerable to the failure of their systems and to
obtain year 2000 compliance certification. The year 2000 issue has not posed
significant operational problems to Finlay.
Finlay used a combination of internal and external resources to execute its
year 2000 project plan. The costs related to the Company's year 2000 efforts
totaled approximately $4.0 million, of which approximately $2.1 million was
spent in 1999. Finlay funded the year 2000 costs through operating cash flows.
During 1998, the Company began several information technology initiatives,
including the design and development of a new merchandising system and the
upgrade of point-of-sale systems and related hardware in the majority of
Finlay's departments. These projects will serve to support future growth of the
Company as well as provide improved analysis and reporting capabilities and are
expected to be completed by mid-2001. The cost associated with these projects is
estimated to be $14.0 million for software and implementation costs, to be
included in Deferred charges and other assets, and approximately $4.0 million
for hardware and related equipment, included as a component of the Company's
capital expenditures and reflected in Fixed assets. At January 29, 2000,
approximately $10.3 million was expended and included in Deferred charges and
other assets.
Section 382 of the Internal Revenue Code of 1986, as amended (the "Code")
restricts utilization of net operating loss ("NOL") carryforwards after an
ownership change exceeding 50%. As a result of the 1993 Recapitalization, a
change in ownership of the Company exceeding 50% occurred within the meaning of
Section 382 of the Code. Similar restrictions apply to other carryforwards.
Consequently, there is a material limitation on the Company's annual utilization
of its NOLs and other carryforwards which requires a deferral or loss of the
utilization of such NOLs or other carryforwards. The Company had, at October 31,
1999 (the Company's tax year end), a NOL for tax purposes of approximately $7.5
million which is subject to an annual limit of approximately $2.0 million per
year. However, for financial reporting purposes, no NOL exists as of January 29,
2000.
From time to time, Finlay enters into futures contracts, such as options or
forwards, based upon the anticipated sales of gold product in order to hedge
against the risk arising from its payment arrangements. Changes in the market
value of futures contracts are accounted for as an addition to or reduction from
the inventory cost. For the year ended January 29, 2000, the gain or loss on
open futures contracts was not material. At January 29, 2000, the Company had
two open positions in futures contracts for gold totaling 25,000 fine troy
ounces, valued at $7.3 million, which expire during the first quarter of 2000.
There can be no assurance that these hedging techniques will be successful or
that hedging transactions will not adversely affect the Company's results of
operations or financial position.
Finlay believes that, based upon current operations, anticipated growth,
and availability under the Revolving Credit Agreement, Finlay Jewelry will, for
the foreseeable future, be able to meet its debt service and anticipated working
capital obligations, and to make distributions to the Company sufficient to
permit the Company to meet its debt service obligations and to pay certain other
expenses as they come
27
due. No assurances, however, can be given that Finlay Jewelry's current level of
operating results will continue or improve or that Finlay Jewelry's income from
operations will continue to be sufficient to permit Finlay Jewelry and the
Company to meet their debt service and other obligations. Currently, Finlay
Jewelry's principal financing arrangements restrict annual distributions from
Finlay Jewelry to the Company to 0.25% of Finlay Jewelry's net sales for the
preceding fiscal year and also allow distributions to the Company to enable it
to make interest payments on the Senior Debentures. The amounts required to
satisfy the aggregate of Finlay Jewelry's interest expense and required
amortization payments totaled $24.5 million and $21.4 million for 1998 and 1999,
respectively.
SEASONALITY
Finlay's business is highly seasonal, with a significant portion of its
sales and income from operations generated during the fourth quarter of each
year, which includes the year-end holiday season. The fourth quarter accounted
for an average of 43% of Finlay's domestic sales and 81% of its domestic income
from operations for 1997, 1998 and 1999. Finlay has typically experienced net
losses in the first three quarters of its fiscal year. During these periods,
working capital requirements have been funded by borrowings under the Revolving
Credit Agreement. Accordingly, the results for any of the first three quarters
of any given fiscal year, taken individually or in the aggregate, are not
indicative of annual results. See Note 10 of Notes to Consolidated Financial
Statements of the Company.
The Company's Sales and Income (loss) from operations for each quarter of
1997, 1998 and 1999 were as follows:
Fiscal Quarter
---------------------------------------------------------------
First Second Third Fourth
-------------- ------------ ------------ ------------
(dollars in thousands)
1997:
Sales....................................... $ 134,592 $ 148,060 $ 148,770 $ 338,440
Income (loss) from operations............... 950 6,585 3,999 50,303
1998:
Sales....................................... 160,992 177,366 165,894 359,176
Income (loss) from operations............... 2,146 6,152 1,844 51,512
1999:
Sales....................................... 168,379 183,367 175,280 385,952
Income (loss) from operations (1)........... 2,356 6,883 2,694 26,524
(1) The fourth quarter of 1999 includes $28.6 million (pre-tax) of expenses
associated with the sale and closure of Sonab.
Inflation
The effect of inflation on Finlay's results of operations has not been
material in the periods discussed.
28
Special Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K ("Form 10-K") includes "forward-looking
statements" within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. All statements other than statements of historical
information provided herein are forward-looking statements and may contain
information about financial results, economic conditions, trends and known
uncertainties. The forward-looking statements contained herein are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those reflected in the forward-looking statements. Factors that
might cause such a difference include, but are not limited to, those discussed
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations", as well as trends in the general economy in the United States,
competition in the retail jewelry business, the seasonality of the retail
jewelry business, the Company's ability to increase comparable Department sales
and to open new Departments, the Company's dependence on certain host store
relationships due to the concentration of sales generated by such host stores,
the availability to the Company of alternate sources of merchandise supply in
the case of an abrupt loss of any significant supplier, the Company's ability to
continue to obtain substantial amounts of merchandise on consignment, the
Company's ability to estimate the costs relating to the closure of Sonab, the
Company's dependence on key officers, the Company's ability to integrate future
acquisitions into its existing business, the Company's high degree of leverage
and the availability to the Company of financing and credit on favorable terms
and changes in regulatory requireme