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 February 2, 2002
[_] 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.
(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
(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, 2002 was $99,903,127.
As of April 24 2002, there were 9,430,561 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 2002, are incorporated by reference into Part
III. The Company's Proxy Statement will be filed within 120 days after February
2, 2002.
FINLAY ENTERPRISES, INC
FORM 10-K
FOR THE FISCAL YEAR ENDED FEBRUARY 2, 2002
INDEX
Page(s)
-------
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......................20
Item 7a. Quantitative and Qualitative Disclosures about
Market Risk..............................................31
Item 8. Financial Statements and Supplementary Data.................32
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure......................32
PART III
Item 10. Directors and Executive Officers of the Registrant..........33
Item 11. Executive Compensation......................................36
Item 12. Security Ownership of Certain Beneficial Owners
and Management...........................................36
Item 13. Certain Relationships and Related Transactions..............39
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K..............................................40
SIGNATURES ............................................................46
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 and Finlay Jewelry. 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 in major department
stores for retailers such as The May Department Stores Company ("May"),
Federated Department Stores ("Federated"), Belk, the Carson Pirie Scott division
of Saks Incorporated, Marshall Field's and Dillard'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 sales price of approximately $183 per item. Average
sales per Department were $925,000 in 2001 and the average size of a Department
is approximately 700 square feet.
On a domestic basis, Finlay's sales have increased from $719.6 million in
1997 to $952.8 million in 2001, a compound annual growth rate of 7.3%. Income
from operations before depreciation and amortization expenses has increased from
$68.8 million to $79.3 million in the same period. Finlay has increased in size
from 797 locations at the beginning of 1997 to 1,006 locations at the end of
2001.
As of February 2, 2002, Finlay operated its 1,006 locations in 22 host
store groups, in 45 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 434
department stores. Finlay's second largest host store relationship is with
Federated, for which Finlay has operated Departments since 1983. Finlay operates
Departments in 159 of Federated's 458 department stores. Over the past three
years, store groups owned by May and Federated accounted for an average of 47%
and 22%, respectively, of Finlay's domestic sales. Management believes that it
maintains excellent relations with its host store groups, 17 of which have had
leases with Finlay for more than five years (representing 78% of Finlay's sales
in 2001) and 15 of which have had leases with Finlay for more than ten years
(representing 74% of Finlay's sales in 2001).
As a result of Federated's closure of its Stern's division, Finlay closed
23 Stern's Departments during the Spring of 2001. Subsequently, Federated
converted the majority of the Departments to a host store in which Finlay does
not operate. Additionally, during 2001, Federated acquired the Liberty House
department store chain and converted those Departments to a host store in which
Finlay does not operate. Finlay operated in all twelve of the Liberty House
department stores through mid-November 2001.
On April 3, 2000, Finlay completed the acquisition of certain assets of Jay
B. Rudolph, Inc. ("J.B. Rudolph") for $20.6 million, consisting primarily of
inventory and fixed assets. By acquiring J.B. Rudolph (the "J.B. Rudolph
Acquisition"), Finlay added 57 Departments and also added new host store
relationships with Bloomingdale's, and Dayton's and Hudson's (both now operating
as Marshall Field's). Finlay financed the J.B. Rudolph Acquisition with
borrowings under Finlay's revolving credit agreement with General Electric
Capital Corporation and the other lenders thereto (the "Revolving Credit
Agreement"). The J.B. Rudolph Acquisition was accounted for as a purchase, and,
accordingly, the operating results of the former J.B. Rudolph departments have
been included in the Company's consolidated financial statements since the date
of acquisition.
3
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 in 1999. The Company recorded a pre-tax
charge 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.
On December 1, 2000, the Company announced that its Board of Directors had
approved a stock repurchase program to acquire up to $20 million of outstanding
common stock, par value $.01 per share ("Common Stock"). The Company may, at the
discretion of management, purchase its Common Stock, from time to time through
September 30, 2002 under the stock repurchase program. The extent and timing of
repurchases will depend upon general business and market conditions, stock
prices, availability under Finlay's revolving credit facility, compliance with
certain restrictive covenants and its cash position and requirements going
forward. To date, the Company has repurchased 1,126,892 shares for $11.2
million.
On April 24, 1998, the Company completed a public offering of 1,800,000
shares of its 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 8_% Senior
Notes due May 1, 2008 (the "Senior Notes"), respectively. In addition, on April
24, 1998, Finlay's 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 10_% Senior Notes due 2003 (the "Old Notes"), including associated
premiums. The above transactions, excluding the 1998 Offering, are referred to
herein as the "Refinancing".
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 1997, 1998, 1999, 2000, 2001 and 2002 relate to the fiscal years ending on
January 31, 1998, January 30, 1999, January 29, 2000, February 3, 2001, February
2, 2002 and February 1, 2003, respectively. Each of the fiscal years includes 52
weeks except 2000, which includes 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.
4
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.
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 $51.3 billion on jewelry
(including both fine and costume jewelry) in the United States in 2001, an
increase of approximately $21.2 billion over 1991, according to the United
States Department of Commerce. In the department store sector in which Finlay
operates, consumers spent $4.3 billion on fine jewelry in 2000. 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:
o Increase Comparable Department Sales. In 1999 and 2000, Finlay achieved
domestic comparable Department sales increases of 8.1% and 2.1%,
respectively. During 2001, Finlay's comparable Department sales decreased
by 3.0% due to the challenging retail environment. Finlay's merchandising
and marketing strategy includes 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 benefit from these strategies.
o 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 434 department
stores. Finlay has also operated Departments in Federated stores since 1983
and operates Departments in 159 of Federated's 458 department stores.
5
o 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 or have an interest in
opening jewelry departments. Finlay seeks to establish these new
relationships by demonstrating to department store management the potential
for improved financial performance. Finlay has added such host store groups
as Burdines, The Bon Marche and Elder Beerman. Through acquisitions Finlay
has added Marshall Field's, Parisian, Dillard's and Bloomingdale's to its
host store relationships.
o Improve Operating Leverage. Selling, general and administrative expenses as
a percentage of sales, on a domestic basis, declined from 42.2% in 1997 to
41.4% in 2001. 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 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.
6
The Finlay Triangle
-------------
/ CENTRAL /\
/ OFFICE \
/ /\ ------------- \ \
/ / \ \
/ / \ \
/ / \ \
\/ / \/ \
------------- -------------
VENDORS <------ STORE
------> MANAGEMENT
------------- -------------
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 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 February 2, 2002, Finlay operated 1,006
locations (including one stand-alone store) in 22 host store groups, in 45
states and the District of Columbia. By acquiring Diamond Park in 1997, Finlay
added 139 Departments in three host store groups. By acquiring J.B. Rudolph in
April 2000, Finlay added 57 Departments in three host store groups. 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 434 department stores. Finlay's second largest host store relationship is
with Federated, for which Finlay has operated Departments since 1983. Finlay
operates Departments in 159 of Federated's 458 department stores. Over the past
three years, store groups owned by May and Federated accounted for an average of
47% and 22%, respectively, of Finlay's domestic sales.
Finlay also operates 119 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, 17 of which have had leases with
Finlay for more than five years (representing 78% of Finlay's sales in 2001) and
15 of which have had leases with Finlay for more than ten years (representing
74% of Finlay's sales in 2001). 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 February 2, 2002, 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 location.
Host Store Group/Location
Inception of Number of
May Relationship Departments
------------ -----------
Robinsons-May.................................................. 1948 56
Filene's....................................................... 1977 42
Lord & Taylor.................................................. 1978 84
Famous Barr/L.S. Ayres/Jones................................... 1979 43
Kaufmann's..................................................... 1979 51
Foley's........................................................ 1986 65
Hecht's/Strawbridge's.......................................... 1986 79
Meier & Frank.................................................. 1988 14
----
Total May Departments...................................... 434
Federated
Rich's/Lazarus/Goldsmith's..................................... 1983 69
Burdines....................................................... 1992 46
The Bon Marche................................................. 1993 21
Bloomingdale's................................................. 2000 23
----
Total Federated Departments................................ 159
Saks Incorporated
Younkers....................................................... 1973 32
Carson Pirie Scott/Bergner's/Boston Store...................... 1977 51
Parisian....................................................... 1997 33
Herberger's.................................................... 1999 3
----
Total Saks Incorported Departments........................ 119
Other Departments
Gottschalks.................................................... 1969 38
Belk........................................................... 1975 63
The Bon-Ton.................................................... 1986 44
Elder Beerman.................................................. 1992 35
Dillard's...................................................... 1997 56
Marshall Field's (1)........................................... 1997 57
----
Total Other Departments.................................... 293
-----
Total Departments.......................................... 1,005
Stand-Alone Store
New York Jewelry Outlet........................................ 1994 1
-----
Total..................................................... 1,006
=====
- ----------
(1) Includes the former Dayton's and Hudson's Departments added in 2000 as a
result of the J.B. Rudolph Acquisition.
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. Substantially all of Finlay's lease agreements
contain renewal options or provisions for automatic renewal absent prior notice
of termination by either party. Lease renewals are generally 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 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 are required to 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 several 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 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 and the J.B.
Rudolph Acquisition.
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 2001, Department openings offset by
closings resulted in a net decrease of 47 Departments. The openings totaled 33
Departments, and were all within existing store groups. The closings totaled 80
Departments and included 23 Departments as a result of Federated's closure of
its Stern's division, 16 Proffitt's Departments as a result of closing a number
of smaller Departments as well as Proffitt's consolidation of its stores at the
end of 2001 under one lessee and twelve Departments as a result of Federated's
acquisition of the Liberty House department store chain. The balance of the
closings were within existing store groups. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--2001 Compared with
2000".
The following table sets forth data regarding the number of domestic
Departments and stand-alone stores which Finlay has operated from the beginning
of 1997:
Fiscal Year Ended
-------------------------------------------------------------
Jan. 31, Jan. 30, Jan. 29, Feb. 3, Feb. 2,
1998 1999 2000 2001 2002
-------- -------- -------- -------- -------
Departments/Stores:
Open at beginning of period.................... 797 959 959 987 1,053
Opened during period........................... 172 68 61 86 33
Closed during period........................... (10) (68) (33) (20) (80)
--- --- --- ----- -----
Open at end of period.......................... 959 959 987 1,053 1,006
--- --- --- ----- -----
Net increase (decrease)........................ 162 -- 28 66 (47)
=== === === ===== =====
For the periods presented in the table above, Department closings were
primarily attributable to: ownership changes in host store groups; the
bankruptcy of certain host store groups; internal consolidation within host
store groups; the closing or sale by host store groups of individual stores;
host store group decisions to consolidate with one lessee; and Finlay's decision
to close unprofitable Departments. To management's knowledge, none of the
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 1999, 2000 and 2001:
Fiscal Year Ended
-----------------------------------------------------------------------------
Jan. 29, 2000 Feb. 3, 2001 Feb. 2, 2002
------------------------ ----------------------- -----------------------
% of % of % of
Sales Sales Sales Sales Sales Sales
----------- ---------- ---------- ---------- ---------- ----------
(Dollars in millions)
Diamonds.................. $ 219.1 24.7% $ 267.7 26.7% $ 264.0 27.7%
Gold...................... 193.1 21.8 222.3 22.2 216.1 22.7
Gemstones................. 194.5 22.0 209.5 21.0 201.7 21.2
Watches................... 151.7 17.1 167.9 16.8 152.2 16.0
Other (1)................. 127.8 14.4 132.7 13.3 118.8 12.4
-------- ----- --------- ----- --------- -----
Total Sales............... $ 886.2 100.0% $ 1,000.1 100.0% $ 952.8 100.0%
======== ===== ========= ===== ========= =====
- ----------
(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 2001, the average price of items sold by Finlay was approximately
$183 per item. An average Department has over 5,000 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. 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 2001, 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 coordination with national or regional
advertising campaigns conducted by the vendors or their service organizations.
11
In 2001, merchandise obtained by Finlay from its 40 largest vendors (out of
a total of approximately 500 vendors) generated approximately 77% of sales, and
merchandise obtained from Finlay's largest vendor generated approximately 10% of
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 an amended and
restated gold consignment agreement (the "Gold Consignment Agreement"), which
expires on June 30, 2002. Finlay Jewelry is currently in the process of amending
and extending the Gold Consignment Agreement. 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.
Although the gold consignor has increased the limit to the lesser of (i) 160,000
fine troy ounces or (ii) $45.0 million worth of gold, subject to a formula as
prescribed by the Gold Consignment Agreement, Finlay Jewelry is currently
limited by the Senior Indentures (as defined in Item 5) to $37.0 million worth
of gold. Finlay intends to obtain approval for the increase from the holders of
the Senior Notes and Senior Debentures. At February 2, 2002, amounts outstanding
under the Gold Consignment Agreement totaled 127,519 fine troy ounces, valued at
approximately $36.0 million. The average amount outstanding under the Gold
Consignment Agreement was $33.3 million in 2001.
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 February 2, 2002, was 3.0% 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 groupmanager, 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 seven 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, to improve customer service and, as a result, sales.
12
Finlay had average domestic sales per linear foot of approximately $12,700
in 1999, $13,600 in 2000 and $13,300 in 2001. 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 $911,000, $981,000 and
$925,000 in 1999, 2000 and 2001, 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. In March 2002, the Company
implemented a new merchandising and inventory control system and a point-of-sale
system for Finlay's Departments. These systems will serve to support future
growth of the Company as well as provide improved analysis and reporting
capabilities to facilitate merchandising solutions. Additionally, these systems
will provide the foundation for future productivity and expense control
initiatives.
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 2001, Finlay employed approximately 6,500 persons in the
United States, approximately 95% 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 6,500 employees, approximately 3,400 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 approximately 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 2001, 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 or the gold consignor. 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 approximately 5.4% of the Company's cost of goods sold in 2001.
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 February 2, 2002, the Company
had several open positions in futures contracts, for gold totaling 17,500 fine
troy ounces, valued at $4.8 million, which expire during 2002. The fair market
value of gold under such contracts was $4.9 million at February 2, 2002.
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. For certain operations at 500 Eighth Avenue, New York, New
York, Finlay has leased approximately 9,200 square feet under a lease which
expires September 30, 2002. Finlay also leases retail space for its New York
Jewelry Outlet store in Destin, Florida. 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 2001.
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 2000 and 2001 were as follows:
Fiscal Year Ended
-----------------------------------------------------
February 3, 2001 February 2, 2002
------------------------ ------------------------
High Low High Low
---------- ---------- ---------- ----------
First Quarter................................. $ 13.31 $ 9.63 $ 14.25 $ 9.00
Second Quarter................................ 14.06 11.75 12.92 10.10
Third Quarter................................. 14.63 9.63 13.00 5.45
Fourth Quarter................................ 14.00 9.63 11.11 6.35
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") and the Senior Debentures (the "Senior Debenture
Indenture", and collectively, with the Senior Note Indenture, 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 2001, 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, 2002, there were 9,430,561 shares of Common Stock
outstanding and approximately 59 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, 2002 was $13.05.
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 February 3, 2001 and February 2, 2002 and the statement
of operations data for each of the fiscal years ended January 29, 2000, February
3, 2001 and February 2, 2002 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 January 31, 1998, January 30,
1999 and January 29, 2000 and the statement of operations data for the fiscal
years ended January 31, 1998 and January 30, 1999 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)
-------------------------------------------------------
Jan. 31, Jan. 30, Jan. 29, Feb. 3, Feb. 2,
1998 1999 2000 2001 2002
-------- -------- -------- --------- --------
(Dollars in thousands, except per share data)
Statement of Operations Data:
Sales ............................................ $769,862 $ 863,428 $912,978 $1,000,120 $952,789
Cost of sales .................................... 371,085 421,450 449,912 496,291 479,255
Cost of sales - Sonab inventory write-down (2) ... -- -- 7,839 -- --
-------- --------- -------- ---------- --------
Gross margin (3) ................................. 398,777 441,978 455,227 503,829 473,534
Selling, general and administrative expenses ..... 324,777 364,652 379,083 409,994 394,238
Nonrecurring charges associated with the sale
and closure of Sonab (2) ....................... -- -- 20,792 -- --
Depreciation and amortization .................... 12,163 15,672 16,895 17,549 20,089
-------- --------- -------- ---------- --------
Income (loss) from operations .................... 61,837 61,654 38,457 76,286 59,207
Interest expense, net ............................ 34,115 32,499 29,505 30,057 26,937
Nonrecurring interest associated with
refinancing (4) ................................ -- 655 -- -- --
-------- --------- -------- ---------- --------
Income (loss) before income taxes and
extraordinary charges .......................... 27,722 28,500 8,952 46,229 32,270
Provision (benefit) for income taxes ............. 12,527 11,986 4,889 19,708 13,735
-------- --------- -------- ---------- --------
Income (loss) before extraordinary charges ....... 15,195 16,514 4,063 26,521 18,535
Extraordinary charges from early
extinguishment of debt, net (5) ................ -- 7,415 -- -- --
-------- --------- -------- ---------- --------
Net income (loss) ................................ $ 15,195 $ 9,099 $ 4,063 $ 26,521 $ 18,535
======== ========= ======== ========== ========
Net income (loss) per share applicable to
common shares: Basic net income
(loss) per share:
Before extraordinary charges ................. $ 1.89 $ 1.61 $ 0.39 $ 2.54 $ 1.82
Extraordinary charges from early
extinguishment of debt ..................... $ -- $ (0.72) $ -- $ -- $ --
Net income (loss) ............................ $ 1.89 $ 0.89 $ 0.39 $ 2.54 $ 1.82
Diluted net income (loss) per share:
Before extraordinary charges ................. $ 1.84 $ 1.59 $ 0.39 $ 2.52 $ 1.80
Extraordinary charges from early
extinguishment of debt ..................... $ -- $ (0.72) $ -- $ -- $ --
Net income (loss) ............................ $ 1.84 $ 0.88 $ 0.39 $ 2.52 $ 1.80
Weighted average number of shares and share
equivalents outstanding (000's) ................ 8,276 10,366 10,504 10,508 10,301
17
Fiscal Year Ended (1)
-----------------------------------------------------------------
Jan. 31, Jan. 30, Jan. 29, Feb. 3, Feb. 2,
1998 1999 2000 2001 2002
--------- --------- --------- --------- ---------
(Dollars in thousands, except per share data)
Pro Forma Consolidated Statement of
Operations Data (6):
Net income (loss) ........................... $ 16,914 $ 21,099
Net income (loss) per share applicable to
common shares:
Basic net income (loss) per share ......... $ 1.65 $ 2.03
Diluted net income (loss) per share ....... $ 1.63 $ 2.01
Pro Forma Domestic Statement of
Operations Data (7):
Sales ....................................... $ 719,607 $ 822,035 $ 886,223
EBITDA (8) .................................. $ 68,825 $ 77,123 $ 87,159
Net income (loss) ........................... $ 14,123 $ 18,850 $ 24,616
Net income (loss) per share applicable to
common shares:
Basic net income (loss) per share ......... $ 1.75 $ 1.84 $ 2.36
Diluted net income (loss) per share ....... $ 1.71 $ 1.82 $ 2.34
Operating and Financial Data:
Number of Departments (end of period) (9):
Consolidated .............................. 1,117 1,109 987 1,053 1,006
Domestic .................................. 959 959 987 1,053 1,006
Percentage increase (decrease) in sales (10) 12.3% 12.2% 5.7% 9.5% (4.7)%
Percentage increase (decrease) in comparable
Department sales (9)(11):
Consolidated .............................. 5.5% 3.9% 6.8% 2.1% (3.0)%
Domestic .................................. 5.7% 5.4% 8.1% 2.1% (3.0)%
Average domestic sales per Department (12) .. $ 820 $ 857 $ 911 $ 981 $ 925
EBITDA (8) .................................. 74,000 77,326 55,352 93,835 79,296
Capital expenditures ........................ 19,338 14,874 14,972 18,118 13,850
Cash flows provided from (used in):
Operating activities ........................ $ 35,910 $ 23,121 $ 38,804 $ 27,860 $ 39,209
Investing activities ........................ (78,915) (23,134) (21,054) (30,403) (17,432)
Financing activities ........................ 36,083 3,692 137 (981) (4,070)
Balance Sheet Data-End of Period:
Working capital ............................. $ 108,395 $ 147,337 $ 157,587 $ 180,274 $ 202,536
Total assets ................................ 508,236 543,992 557,042 604,143 584,853
Short-term debt, including current portion of
long-term debt ............................ -- -- -- -- --
Long-term debt, excluding current portion ... 221,026 225,000 225,000 225,000 225,000
Total stockholders' equity (deficit) ........ 72,339 99,811 108,800 134,340 149,207
(Footnotes continued on following page)
18
- ----------
(1) Each of the fiscal years for which information is presented includes 52
weeks except 2000, 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 13 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: $(2.3) million, $(1.0) million,
$(1.1) million, $1.8 million and $3.8 million for 1997, 1998, 1999, 2000
and 2001, respectively.
(4) 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 interest expense on the borrowings under the Revolving
Credit Agreement and interest income on excess cash balances, was $0.7
million.
(5) 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.
(6) The pro forma financial information for 1998 excludes (i) the extraordinary
charge of $12.2 million, on a pre-tax basis, described in Note 5 above, and
(ii) the nonrecurring interest associated with refinancing, described in
Note 4 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 Note 13 of Notes
to Consolidated Financial Statements.
(7) 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 14 of Notes to Consolidated
Financial Statements. For 1998, refer to Note 6 above for additional pro
forma adjustments.
(8) 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.
(9) Includes Departments and stand-alone locations.
(10) Excluding sales for the 53rd week of 2000, the percentage increase in sales
for 2000 was 8.8% and the percentage decrease in sales for 2001 was 4.1%.
(11) Comparable Department sales are calculated by comparing the sales from
Departments open for the same months in the comparable periods.
(12) 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.
19
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".
Critical Accounting Policies and Estimates
The Company's Consolidated Financial Statements have been prepared in
accordance with accounting principles generally accepted in the United States.
These generally accepted accounting principles require management to make
estimates and assumptions that affect certain financial statement accounts
reported and disclosed at the date of the financial statements. Actual results
could differ from those estimates.
The Company's significant accounting policies are described in Note 2 of
Notes to the Consolidated Financial Statements. The Company believes that the
following discussion addresses the critical accounting policies, which are those
that are most important to the portrayal of the Company's financial condition
and results and require management's most difficult, subjective or complex
judgments. The Company is not aware of any likely events or circumstances which
would result in different amounts being reported that would materially affect
its financial condition or results of operations.
Merchandise Inventories
The Company values its inventories at the lower of cost or market. The cost
is determined by the last-in, first-out method utilizing selected producer price
indices published for jewelry and watches by the Bureau of Labor Statistics.
Factors related to inventories such as future consumer demand and the economy's
impact on consumer discretionary spending, inventory aging, ability to return
merchandise to vendors, merchandise condition and anticipated markdowns are
analyzed to determine estimated net realizable values. A provision is recorded
to reduce the cost of inventories to the estimated net realizable values, if
required. Any significant unanticipated changes in the factors above could have
a significant impact on the value of the inventories and the Company's reported
operating results.
The Company is exposed to market risk related to changes in the price of
gold and at times enters into futures contracts, such as options or forwards, to
hedge against the risk of gold price fluctuations. The Company adopted Statement
of Financial Accounting Standard ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities", which requires that all derivative
instruments be recorded on the balance sheet as either an asset or a liability
measured at its fair value. The impact on the Company's financial condition,
results of operations and cash flows, upon the adoption of SFAS No. 133 was
immaterial.
20
Revenue Recognition
The Company recognizes revenue upon the sale of merchandise, either owned
or consigned, to its customers, net of anticipated returns.
Covenant Requirements
The Company's agreements covering the Revolving Credit Agreement, the
Senior Debentures and the Senior Notes each require that Finlay comply with
certain restrictive and financial covenants. In addition, Finlay Jewelry is
party to the Gold Consignment Agreement, which also contains certain covenants.
Refer to Notes 3 and 4 of Notes to the Consolidated Financial Statements. During
2001, in anticipation of not meeting one of the financial covenants under the
Revolving Credit Agreement, the covenant was amended. As of and for the year
ended February 2, 2002, the Company was in compliance with all of its covenants.
Should the Company's results of operations significantly erode, the Company may
not be in compliance with its covenants. Although management believes that the
Company would be able to obtain a waiver or amendment, in the event that the
Company is unable to obtain such waiver or amendment, the outstanding balances
could become due immediately.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 142 "Goodwill and Other Intangible Assets". SFAS No. 142 requires that
goodwill and intangible assets with indefinite useful lives are no longer to be
amortized but tested for impairment on an annual basis. The Company adopted this
pronouncement in 2002 and is currently evaluating whether goodwill is impaired.
The Company's annual goodwill amortization in 2001 totaled $3.7 million.
In October 2001, the FASB issued SFAS No. 144 "Accounting for Impairment or
Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This extends the
reporting requirements to include reporting separately as discontinued
operations, components of an entity that have either been disposed of or
classified as held-for-sale. The Company has adopted the provisions of SFAS No.
144 in 2002 and does not anticipate that such adoption will have a significant
effect on the Company's results of operations or financial position.
21
Results of Operations
The following table sets forth operating results as a percentage of sales
for the periods indicated:
Fiscal Year Ended
------------------------------------------------
Jan. 29, Feb. 3, Feb. 2,
2000 2001 2002
------------ ------------- ------------
Statement of Operations Data:
Sales.................................................... 100.0% 100.0% 100.0%
Cost of sales............................................ 49.3 49.6 50.3
Cost of sales - Sonab inventory write-down (1)........... 0.8 -- --
------------ ------------- ------------
Gross margin........................................... 49.9 50.4 49.7
Selling, general and administrative expenses............. 41.5 41.0 41.4
Nonrecurring charges associated with the sale
and closure of Sonab (1).............................. 2.3 -- --
Depreciation and amortization............................ 1.9 1.8 2.1
------------ ------------- ------------
Income (loss) from operations............................ 4.2 7.6 6.2
Interest expense, net.................................... 3.2 3.0 2.8
------------ ------------- ------------
Income (loss) before income taxes........................ 1.0 4.6 3.4
Provision for income taxes............................... 0.5 2.0 1.4
------------ ------------- ------------
Net income (loss)....................................... 0.5% 2.6% 2.0%
============ ============= ============
Other Supplemental Data:
EBITDA (2)(3)............................................ 6.1% 9.4% 8.3%
- ----------
(1) See Note 2 to "Selected Consolidated Financial Data".
(2) 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 8 to "Selected Consolidated Financial Data".
(3) 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%.
2001 Compared with 2000
Sales. Sales decreased $47.3 million, or 4.7%, in 2001 compared to 2000.
Excluding sales for the 53rd week of 2000, sales decreased 4.1%. Comparable
Department sales decreased 3.0%. Management attributes this decrease in
comparable Department sales primarily to a challenging retail environment and
the extraordinary events of September 11, 2001 and its impact on the economy,
which resulted in reduced consumer discretionary spending. Total sales were
negatively impacted by $17.3 million as a result of closing the Stern's and
Liberty House Departments offset by the benefit of a full year of sales from the
former J.B. Rudolph departments and the net effect of new Department openings
and closings.
Finlay's merchandising and marketing strategy includes the following
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; and (iii) positioning the Company's Departments as a
"destination location" for fine jewelry.
22
During 2001, Finlay opened 33 Departments within existing store groups,
which included 22 Departments in May. During this period Finlay closed 80
Departments which were comprised of the following:
Number of
Store Group Departments Reason
----------------------------------- ----------- --------------------------------------------------------
Stern's......................... 23 Store group was closed by Federated.
Proffitt's...................... 16 Closed smaller Departments and, at the end of 2001, host
store consolidated under one lessee.
Liberty House................... 12 Federated's acquisition of Liberty House.
Dillard's....................... 7 Closed smaller Departments.
Other........................... 22 Department closings within existing store groups.
----
80
====
Gross margin. Gross margin decreased by $30.3 million in 2001 compared to
2000 and, as a percentage of sales, gross margin decreased by 0.7%, primarily
due to (i) management's continued efforts to increase market penetration and
market share through its pricing strategy, (ii) a charge of $3.8 million in the
LIFO provision compared to the prior year's provision of $1.8 million and (iii)
a charge of $1.5 million for the markdown of aged inventory.
Selling, general and administrative expenses. SG&A totaled $394.2 million,
a decrease of $15.8 million, or 3.8%, in 2001 compared to 2000 due primarily to
payroll expense and lease fees associated with the decrease in the Company's
sales. SG&A as a percentage of sales increased to 41.4% in 2001 from 41.0% in
2000 as a result of the negative impact of payroll and other expenses as a
percentage of sales due to the lower sales volume.
Depreciation and amortization. Depreciation and amortization increased by
$2.5 million in 2001 compared to 2000, reflecting $13.9 million in capital
expenditures and an increase in capitalized software costs for the most recent
twelve months. Additionally, during 2001, the Company began amortizing the
capitalized software for its new merchandising and point-of-sale systems. These
costs were 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 $3.1 million
reflecting a lower weighted average interest rate (7.8% for 2001 compared to
8.6% for 2000) and a decrease in average borrowings ($305.8 million for 2001
compared to $321.6 million for 2000).
Provision for income taxes. The income tax provision for 2001 and 2000
reflects an effective tax rate of 40.5%.
Net income. Net income of $18.5 million for 2001 represents a decrease of
$8.0 million as compared to net income of $26.5 million in 2000 as a result of
the factors discussed above.
23
2000 Compared with 1999
Sales. Sales increased $87.1 million, or 9.5%, in 2000 compared to 1999.
Comparable Department sales increased 2.1%. 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. These
factors were offset by a general softening in the retail environment in the
latter part of 2000. Sales from the operation of net new Departments contributed
$68.0 million, primarily relating to the J.B. Rudolph Acquisition and the net
effect of new Department openings and closings offset by the sale and closure of
Sonab at the end of 1999. Excluding Sonab's sales which totaled $26.8 million in
1999, sales on a domestic basis increased 12.9% in 2000.
During 2000, Finlay opened 86 Departments and closed 20 Departments. The
Department openings were comprised of the following:
Number of
Store Group Departments Reason
----------------------------------- ----------- ---------------------------------------------------
Bloomingdale's.................. 23 J.B. Rudolph Acquisition.
Hudson's........................ 21 J.B. Rudolph Acquisition.
Dayton's........................ 13 J.B. Rudolph Acquisition.
Meier & Frank................... 7 May's acquisition of ZCMI.
Other........................... 22 Department openings within existing store groups.
----
86
====
The Department closings were comprised of the following:
Number of
Store Group Departments Reason
----------------------------------- ----------- ---------------------------------------------------
New York Jewelry Outlet......... 6 Sold in May 2000.
Other........................... 14 Department closings within existing store groups.
----
20
====
Gross margin. Gross margin increased by $48.6 million in 2000 compared to
1999 and, as a percentage of sales, gross margin increased by 0.5%, primarily
due to a nonrecurring charge in 1999 of $7.8 million relating to the write-down
of inventory in conjunction with the sale and closure of Sonab's operations
offset by (i) management's continued efforts to increase market penetration and
market share through its pricing strategy and (ii) a charge of $1.8 million in
the LIFO provision compared to the prior year's benefit of $1.0 million.
Selling, general and administrative expenses. SG&A totaled $410.0 million,
an increase of $30.9 million, or 8.2%, in 2000 compared to 1999 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 41.0% in 2000 from 41.5% in
1999 as a result of the negative impact of Sonab's 1999 SG&A as a percentage of
sales in addition to expenses related to the Company's year 2000 remediation
project of approximately $2.0 million in 1999. On a domestic basis, SG&A as a
percentage of sales improved 0.1%.
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 in
1999. 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.
24
Depreciation and amortization. Depreciation and amortization increased by
$0.7 million in 2000 compared to 1999, reflecting $18.1 million in capital
expenditures and an increase in capitalized software costs for the most recent
twelve months. These costs were offset by the effect of certain assets becoming
fully depreciated, as well as the disposition and write-off of Sonab's fixed
assets. On a domestic basis, depreciation and amortization increased by $1.3
million. The increase in fixed assets was primarily due to the addition of new
Departments, the renovation of existing Departments and the inclusion of the
cost of fixed assets acquired in connection with the J.B. Rudolph Acquisition.
Interest expense, net. Interest expense increased by $0.6 million
reflecting a higher weighted average interest rate (8.6% for 2000 compared to
8.2% for 1999) offset slightly by a decrease in average borrowings ($321.6
million for 2000 compared to $329.2 million for 1999).
Provision for income taxes. The income tax provision for 2000 and 1999
reflects an effective tax rate of 40.5%.
Net income. Net income of $26.5 million for 2000 represents an increase of
$22.4 million as compared to net income of $4.1 million in 1999 as a result of
the factors discussed above. Excluding the nonrecurring charges in 1999 relating
to the sale and closure of Sonab, net income for 2000, on a domestic basis,
increased by $1.9 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 2000 and 2001,
capital expenditures totaled $14.1 million (exclusive of the fixed assets
acquired in the J.B. Rudolph Acquisition, which totaled $4.0 million) and $13.9
million, respectively. Total capital expenditures for 2002 are estimated to be
approximately $12.0 to $13.0 million. 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 as Finlay's
lease agreements 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. 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 $202.5 million at February 2, 2002, an
increase of $22.3 million from February 3, 2001. The increase resulted primarily
from the impact of 2001's net income, exclusive of depreciation and amortization
and fixed asset disposals associated with closed store groups, partially offset
by capital expenditures, additions to deferred charges and the purchase of
treasury stock.
The seasonality of Finlay's business causes working capital requirements,
and therefore borrowings under the Revolving Credit Agreement, 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. During 2001, by closely monitoring sales and the
effects of the slowing economy, the Company reduced inventory by 6% over the
previous year. This had a favorable impact on the Company's liquidity.
Additionally, Finlay's lease agreements provide for accelerated payments during
the months of November and December, which require most host store groups to
remit to Finlay 75% of the estimated months' sales prior to or shortly following
the end of that month. These proceeds result in a significant increase in the
Company's cash, which is used to reduce the Company's borrowings under the
Revolving Credit Agreement.
25
The Revolving Credit Agreement, which expires in March 2003, provides
Finlay with a line of credit of up to $275.0 million, inclusive of a $50.0
million acquisition facility, to finance working capital needs. The Company
intends to renew the Revolving Credit Agreement and expects to begin this
process during the summer of 2002. There can be no assurances that a new
revolving credit facility will be executed on terms equal to or more favorable
than the expiring Revolving Credit Agreement, or that a new agreement can be
completed at all. Finlay would be adversely affected if it were unable to secure
a new revolving credit facility. 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
the Revolving Credit Agreement at February 2, 2002 and February 3, 2001 were
zero. The average amounts outstanding under the Revolving Credit Agreement for
2000 and 2001 were $96.6 million and $80.8 million, respectively. The maximum
amount outstanding for 2001 was $125.2 million, at which point the unused excess
availability was $95.5 million, excluding the acquisition facility. At February
2, 2002, the Company was in compliance with all of its covenants under the
Revolving Credit Agreement.
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 February 2, 2002, $359.7
million of consignment merchandise from approximately 300 vendors was on hand as
compared to $381.7 million at February 3, 2001. For 2001, Finlay had an average
balance of consignment merchandise of $377.4 million as compared to an average
balance of $372.9 million in 2000. See "Business--Store Relationships" and
"Business--Purchasing and Inventory".
A significant amount of Finlay's operating cash flow has been used or will
be required to pay interest, directly or indirectly, 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 February 2, 2002, 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. At February 2, 2002, the
Company was in compliance with all of its covenants under the Senior Indentures.
Finlay Jewelry is party to the Gold Consignment Agreement, which expires on
June 30, 2002. The Gold Consignment Agreement enables Finlay Jewelry to receive
merchandise by providing gold, or otherwise making payment, to certain vendors.
While the merchandise involved remains consigned, title to the gold content of
the merchandise transfers from the vendors to the gold consignor. Although the
gold consignor has increased the limit to the lesser of (i) 160,000 fine troy
ounces or (ii) $45.0 million worth of gold, subject to a formula as prescribed
by the Gold Consignment Agreement, Finlay Jewelry is currently limited by the
Senior Indentures to $37.0 million worth of gold. Finlay intends to obtain
approval for the increase from the holders of the Senior Notes and Senior
Debentures. Finlay Jewelry is currently in the process of amending and extending
the Gold Consignment Agreement, however there are no assurances that this will
be completed. At February 2, 2002, amounts outstanding under the Gold
Consignment Agreement totaled 127,519 fine troy ounces, valued at approximately
$36.0 million. The average amount outstanding under the Gold Consignment
Agreement was $33.3 million in 2001. At February 2, 2002, Finlay Jewelry was in
compliance with the covenants under the Gold Consignment Agreement.
26
The following tables summarize the Company's contractual and commercial
obligations which may have an impact on future liquidity and the availability of
capital resources, as of February 2, 2002 (dollars in thousands):
Payments Due By Period
---------------------------------------------------
Less than 1 - 3 4 - 5 After
Contractual Obligations Total 1 year years years 5 years
- --------------------------------- ------- --------- ----- ----- -------
Senior Notes (due 2008) ......... $150,000 $ -- $ -- $ -- $150,000
Senior Debentures (due 2008)..... 75,000 -- -- -- 75,000
Operating leases (1)............. 19,346 3,263 6,481 6,407 3,195
-------- -------- -------- -------- --------
Total ........................... $244,346 $ 3,263 $ 6,481 $ 6,407 $228,195
======== ======== ======== ======== ========
- ----------
(1) Represents future minimum payments under noncancellable operating leases.
Amount of Commitment Expiration Per Period
---------------------------------------------------
Other Commercial Less than 1 - 3 4 - 5 After
Commitments Total 1 year years years 5 years
- --------------------------------- ------- --------- ----- ----- -------
Revolving Credit
Agreement (due 2003) (1) .... $ -- $ -- $ -- $ -- $ --
Gold Consignment
Agreement (due 2002) (2) 36,000 36,000 -- -- --
Letters of credit ............... 4,250 2,000 2,250 -- --
-------- -------- -------- -------- --------
Total ........................... $ 40,250 $ 38,000 $ 2,250 $ -- $ --
======== ======== ======== ======== ========
- ----------
(1) There were no borrowings under the Revolving Credit Agreement at February
2, 2002. The average amount outstanding during 2001 was $80.8 million and
the outstanding balance as of April 15, 2002 was $59.2 million.
(2) Represents amount outstanding at February 2, 2002.
Finlay believes that, based upon current operations, anticipated growth,
and continued 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 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 $22.2
million and $19.0 million for 2000 and 2001, respectively.
On December 1, 2000, the Company announced that its Board of Directors had
approved a stock repurchase program to acquire up to $20 million of outstanding
Common Stock. The Company may, at the discretion of management, purchase its
Common Stock, from time to time through September 30, 2002 under the stock
repurchase program. The extent and timing of repurchases will depend upon
general business and market conditions, stock prices, availability under
Finlay's revolving credit facility, compliance with certain restrictive
covenants and its cash position and requirements going forward. To date, the
Company has repurchased 1,126,892 shares for $11.2 million.
27
In March 2002, the Company implemented a new merchandising and inventory
control system and a point-of-sale system for Finlay's Departments. These
systems will serve to support future growth of the Company as well as provide
improved analysis and reporting capabilities and more timely sales and inventory
information to facilitate merchandising solutions. Additionally, these systems
will provide the foundation for future productivity and expense control
initiatives. At February 2, 2002, a total of approximately $18.8 million has
been expended for software and implementation costs and is 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 certain recapitalization
transactions in 1993, 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 such NOLs or other carryforwards. The
Company had, at October 31, 2001 (the Company's tax year end), a NOL for tax
purposes of approximately $3.5 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 February 2, 2002.
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 February 2, 2002, the gain or loss on
open futures contracts was not material. At February 2, 2002, the Company had
several open positions in futures contracts for gold, which expire during 2002,
totaling 17,500 fine troy ounces, valued at $4.8 million. 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.
On February 8, 2001, Federated announced its plans to close its Stern's
division of which Finlay operated 23 Departments. During March 2001, Finlay
closed two Departments and the remaining 21 Stern's Departments were closed
during the second quarter of 2001. Subsequently, Federated converted the
majority of the Departments to a host store in which Finlay does not operate.
Finlay's 2001 sales were reduced by approximately $16.0 million as a result of
these closings. In 2001, Finlay recorded a charge of approximately $1.0 million
related to the write-off of fixed assets and employee severance.
During 2001, Federated acquired the Liberty House department store chain
and converted those Departments to a host store in which Finlay does not
operate. Finlay operated in all twelve of the Liberty House department stores
through mid-November 2001. Finlay's 2001 sales were reduced by approximately
$5.0 million as a result of these closings. In 2001, Finlay recorded a charge of
approximately $150,000 related to the write-off of fixed assets and employee
severance.
On April 3, 2000, Finlay completed the acquisition of certain assets of
J.B. Rudolph for $20.6 million, consisting primarily of inventory and fixed
assets. During 2000, the J.B. Rudolph Acquisition required additional working
capital to increase the inventory levels in anticipation of the year-end holiday
season. Finlay financed the J.B. Rudolph Acquisition and subsequent inventory
build-up with borrowings under its Revolving Credit Agreement.
During 1998, Sonab, the Company's European leased jewelry department
subsidiary, began to experience lower sales trends due to the transition from a
promotional pricing strategy to an everyday low price strategy. This change was
made as a result of Sonab reassessing its pricing policy following certain local
French court decisions. The adverse impact of such change continued through
1999. As a result of the foregoing, on January 3, 2000, Sonab sold the majority
of its assets for approximately $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 in the
28
fourth quarter of 1999 of $28.6 million, or $1.62 per share on a diluted basis
after-tax. The charge included the write down of inventory and fixed assets,
employee payroll and severance costs, realization of foreign exchange losses and
other close-down costs. As of February 2, 2002, the Company's exit plan has been
completed with the exception of certain employee litigation and other legal
matters. To date, the Company has charged a total of $26.3 million against its
original estimate of $28.6 million. All of Sonab's employees, excluding those
that were hired by the buyer, were involuntarily terminated, including sales
associates, supervisors and corporate personnel. The Company does not believe
future operating results or liquidity will be materially impacted by any
remaining payments.
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 42% of Finlay's domestic sales and 77% of its domestic income
from operations for 1999, 2000 and 2001. 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
1999, 2000 and 2001 were as follows:
Fiscal Quarter
---------------------------------------------------------------
First Second Third Fourth
-------------- ------------ ------------ ------------
(dollars in thousands)
(unaudited)
1999:
Sales....................................... $ 168,379 $ 183,367 $ 175,280 $ 385,952
Income (loss) from operations (1)........... 2,356 6,883 2,694 26,524
2000:
Sales....................................... 178,614 211,229 189,728 420,549
Income (loss) from operations............... 4,338 10,042 5,431 56,475
2001:
Sales....................................... 193,249 196,167 175,292 388,081
Income (loss) from operations............... 4,125 5,525 1,624 47,933
- ----------
(1) The fourth quarter of 1999 includes $28.6 million (pre-tax) of expenses
associated with the sale and closure of Sonab.
29
Inflation
The effect of inflation on Finlay's results of operations has not been
material in the periods discussed.
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, performances or
achievements to differ materially from those reflected in, or implied by, 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, low or negative growth in the economy
or in the financial markets which reduce discretionary spending on goods
perceived to be luxury items, the events of September 11, 2001 and related
events which negatively impacted the economy and/or the financial markets and
reduced discretionary spending on such goods, 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 compliance with
applicable contractual covenants, 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 requirements
which are applicable to the Company's business. Other such factors include the
ability of the Company to complete the repurchases contemplated under its stock
repurchase program, the adequacy of Finlay's working capital to complete the
repurchases, the availability and liquidity of the Company's Common Stock, and
overall market conditions for the Company's Common Stock.
Readers are cautioned not to rely on these forward-looking statements,
which reflect management's analysis, judgment, belief or expectation only as of
the date hereof. The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect events or circumstances that arise after
the date hereof or to reflect the occurrence of unanticipated events. In
addition to the disclosure contained herein, readers should carefully review any
disclosure of risks and uncertainties contained in other documents the Company
files or has filed from time to time with the Securities and Exchange Commission
(the "Commission") pursuant to the Exchange Act.
30
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risk through the interest rate on its
borrowings under the Revolving Credit Agreement, which has a variable interest
rate. In seeking to minimize the risks from interest rate fluctuations, the
Company manages exposures through its regular operating and financing
activities. In addition, the majority of the Company's borrowings are under
fixed rate arrangements, as described in Note 4 of Notes to Consolidated
Financial Statements. In addition, the Company is exposed to market risk related
to changes in the price of gold, and selectively uses forward contracts to
manage this risk. The Company enters into forward contracts for the purchase of
gold to hedge the risk of gold price fluctuations for future sales of gold
consignment merchandise. The Company does not enter into forward contracts or
other financial instruments for speculation or trading purposes. The fair value
of gold under the forward contracts was $4.9 million at February 2, 2002.
31
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Finlay Enterprises, Inc.
Report of Independent Public Accountants.....................................................................F-2
Consolidated Statements of Operations for the years ended January 29, 2000, February 3, 2001
and February 2, 2002.....................................................................................F-3
Consolidated Balance Sheets as of February 3, 2001 and February 2, 2002......................................F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended
January 29, 2000, February 3, 2001 and February 2, 2002..................................................F-5