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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended January 30, 1999
__ 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: 33-59380
FINLAY FINE JEWELRY CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 13-3287757
-------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
529 Fifth Avenue New York, NY 10017
---------------------------------------- ----------
(Address of principal executive offices) (zip code)
212-808-2800
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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]
As of April 23, 1999, there were 1,000 shares of common stock, par value $.01
per share, of the Registrant outstanding. As of such date, all shares of common
stock were owned by the Registrant's parent, Finlay Enterprises, Inc., a
Delaware corporation.
*The Registrant is not subject to the filing requirements of Section 13 or 15(d)
of the Securities Exchange Act of 1934 and is voluntarily filing this Annual
Report on Form 10-K
FINLAY FINE JEWELRY CORPORATION
FORM 10-K
FOR THE FISCAL YEAR ENDED JANUARY 30, 1999
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..............................19
Item 7a. Quantitative and Qualitative Disclosures about Market Risk..........28
Item 8. Financial Statements and Supplementary Data.........................29
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..............................29
PART III
Item 10. Directors and Executive Officers of the Registrant..................30
Item 11. Executive Compensation..............................................34
Item 12. Security Ownership of Certain Beneficial Owners and Management......43
Item 13. Certain Relationships and Related Transactions......................46
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.....50
SIGNATURES ...................................................................59
2
PART I
Item 1. Business
The Company
Finlay Fine Jewelry Corporation, a Delaware corporation, and its wholly
owned subsidiaries ("Finlay Jewelry"), is a wholly owned subsidiary of Finlay
Enterprises, Inc., a Delaware corporation (the "Holding Company"). References to
"Finlay" mean, collectively, the Holding Company, Finlay Jewelry and all
predecessor businesses. All references herein to "Departments" refer to fine
jewelry departments operated pursuant to license agreements or other
arrangements with host department stores.
Finlay is one of the leading retailers of fine jewelry in the United States
and France. Finlay operates leased fine jewelry departments ("Departments") in
major department stores for retailers such as The May Department Stores Company
("May"), Federated Department Stores ("Federated"), Belk, the Carson Pirie Scott
and Proffitt's divisions of Saks Incorporated, and with the completion of its
1997 acquisition of Diamond Park (as defined herein), operates Departments in
Marshall Field's, Parisian and Dillard's, formerly the Mercantile Stores. 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 $161 per item.
Average sales per Department were $776,000 in 1998 and the average size of a
Department is approximately 1,000 square feet.
Finlay's sales have increased from $552.1 million in 1994 to $863.4 million
in 1998, a compound annual growth rate of 11.8%. Income from operations has
increased from $37.5 million to $62.3 million in the same period, a compound
annual growth rate of 13.5%. Finlay has increased in size from 757 Departments
at the beginning of 1994 to 1,097 Departments and 12 stand-alone stores, for a
total of 1,109 locations at the end of 1998.
As of January 30, 1999, Finlay operated its 1,109 locations in 31 host
store groups, located in 45 states, the District of Columbia, France, England
and Germany. 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 390 department stores, including Lord & Taylor and
Filene's. Finlay's second largest host store relationship is with Federated, for
which Finlay has operated Departments since 1983. Finlay operates Departments in
153 of Federated's 401 department stores, including Rich's and Burdines. Over
the past three years, store groups owned by May and Federated accounted for an
average of 46% and 21%, respectively, of Finlay's annual sales. Management
believes that it maintains excellent relations with its host store groups, 20 of
which have had leases with Finlay for more than five years (representing 79% of
Finlay's sales in 1998) and 16 of which have had leases with Finlay for more
than ten years (representing 69% of Finlay's sales in 1998).
Finlay entered the international fine jewelry retailing market in October
1994 by acquiring Societe Nouvelle d' Achat de Bijouterie--S.O.N.A.B. ("Sonab"),
the largest operator of Departments in France, operating 144 Departments in five
host store groups, including Galeries Lafayette, Nouvelles Galeries and Bazar de
L'Hotel de Ville.
As of January 30, 1999, Finlay also operated nine domestic stand alone
jewelry outlet stores at nonmetropolitan outlet shopping center locations in
Ohio, New York, Florida, South Carolina, Pennsylvania, Georgia and California
under the name "New York Jewelry Outlet". The outlet stores provide Finlay with
a channel to sell discontinued, close-out and certain other merchandise.
3
Finlay's fiscal year ends on the Saturday closest to January 31. References
to 1994, 1995, 1996, 1997, 1998 and 1999 relate to the fiscal years ending on
January 28, 1995, February 3, 1996, February 1, 1997, January 31, 1998, January
30, 1999 and January 29, 2000, respectively. Each of the fiscal years includes
52 weeks except 1995, which included 53 weeks.
Finlay Jewelry is a wholly owned subsidiary of the Holding Company. The
principal executive offices of Finlay Jewelry are located at 529 Fifth Avenue,
New York, New York 10017 and its telephone number at this address is (212)
808-2800.
On April 24, 1998, the Holding Company completed a public offering of
1,800,000 shares of its common stock, par value $.01 per share ("Common Stock"),
at a price of $27.50 per share (the "1998 Offering"), of which 567,310 shares
were sold by the Holding Company and 1,232,690 shares were sold by certain
selling stockholders. Concurrently with the 1998 Offering, the Holding 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 8-3/8% Senior
Notes due May 1, 2008 (the "Senior Notes"), respectively. In addition, on April
24, 1998, Finlay's revolving credit agreement (the "Revolving Credit Agreement")
was amended to increase the line of credit thereunder to $275.0 million and to
make certain other changes.
On May 1, 1998, the Holding Company prepaid all of the $39.0 million of
accreted interest on the Holding Company's 12% Senior Discount Debentures due
2005 (the "Old Debentures") as of such date. The Holding Company exercised its
option to prepay all such accreted interest to take advantage of the resulting
tax benefit relating to the deductibility of such prepayment in 1998.
On May 26, 1998, the net proceeds to the Holding Company from the 1998
Offering, the sale of the Senior Debentures, together with other available
funds, were used to redeem the Holding Company's 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 10-5/8% Senior
Notes due 2003 (the "Old Notes"), including associated premiums. The above
transactions, excluding the 1998 Offering, are referred to herein as the
"Refinancing". Finlay Jewelry recorded, in the second quarter of 1998, a pre-tax
extraordinary charge of approximately $8.0 million, including $5.4 million for
the redemption premium on the Notes and $2.0 million to write off deferred
financing costs associated with the Old Notes.
On October 6, 1997, Finlay completed the acquisition of certain assets of
the Diamond Park Fine Jewelers division of Zale Corporation ("Diamond Park"), a
leading operator of Departments, for approximately $63.0 million. By acquiring
Diamond Park, Finlay added 139 Departments that, in 1998, contributed in excess
of $100 million in sales and also added new host store relationships with
Marshall Field's, Parisian and Dillard's, formerly the Mercantile Stores.
On October 21, 1997, the Holding Company completed a public offering (the
"1997 Offering") of 3,450,000 shares of its Common Stock, at a price of $19.00
per share, of which 2,196,971 shares were issued and sold by the Holding
Company. An additional 1,253,029 shares were sold by existing stockholders. Net
proceeds to the Holding Company from the 1997 Offering were $38.1 million. The
Holding Company used the funds for working capital, repayment of indebtedness
and other general corporate purposes.
On April 6, 1995, the Holding Company completed an initial public offering
(the "Initial Public Offering") of 2,500,000 shares of its Common Stock, at a
price of $14.00 per share. An additional 115,000 shares were sold by
non-management selling stockholders. Net proceeds from the Initial Public
Offering were $30.2 million and were used to repurchase $6.1 million accreted
balance of the Old
4
Debentures, with the balance of the net proceeds used to reduce a portion of the
outstanding indebtedness incurred under the Revolving Credit Agreement.
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 Finlay Jewelry's working capital requirements are lower than those
of many other jewelry retailers. In recent years, on average, approximately 49%
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 $46.3 billion on jewelry
(including both fine and costume jewelry) in the United States in 1998, an
increase of approximately $17.7 billion over 1988, according to the United
States Department of Commerce. In the department store sector in which Finlay
operates, consumers spent $4 billion on fine jewelry in 1997. 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 Finlay'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 pursue the following key initiatives to
increase sales and earnings:
o Increase Comparable Department Sales. In 1996, 1997 and 1998, Finlay
achieved domestic comparable Department sales increases of 6.0%, 5.7% and
5.4%, respectively, outpacing the majority of its host stores. These
increases were achieved primarily by emphasizing key merchandise items,
increasing focus on holiday and event-driven promotions, participating in
host store marketing programs and positioning its Departments as a
"destination location" for fine jewelry. Finlay believes that comparable
Department sales will continue to benefit from these merchandising and
marketing strategies, as well as from increasing demand for fine jewelry.
o Add Departments Within Existing Host Store Groups. Finlay's well
established relationships with many of its host store groups have enabled
Finlay 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 390 department stores. Finlay also
has operated
5
Departments in Federated stores since 1983 and operates Departments in 153
of Federated's 401 department stores. Since the beginning of 1994, host
store expansion has added 92 net new Departments. Based on May's expansion
plans, Finlay believes it will have the opportunity to open approximately
100 new Departments in May stores alone over the next five years (excluding
possible closings).
o Establish New Host Store Relationships. Finlay has an opportunity to grow
by establishing new relationships with department stores that presently
either lease their fine jewelry departments to Finlay's competitors or
operate their own fine jewelry departments. Finlay seeks to establish these
new relationships by demonstrating to department store management the
potential for improved financial performance. Since the beginning of 1992,
Finlay has added such host store groups as Burdines, The Bon Marche, Elder
Beerman and Stern's. Over the past three years, Finlay has added 27
Departments in the Hecht's division of May as a result of May's acquisition
of John Wanamaker and Strawbridge's. By acquiring Diamond Park (the
"Diamond Park Acquisition"), Finlay added Marshall Field's, Parisian and
Dillard's (formerly the Mercantile Stores) to its host store relationships.
o Continue to Improve Operating Leverage. Selling, general and administrative
expenses as a percentage of sales declined from 43.3% in 1994 to 42.2% in
1998. 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 Finlay will benefit from recent investments
in technology and refinements of operating procedures designed to allow
Finlay's sales associates more time for customer sales and service.
Finlay's new central distribution facility, which became fully operational
in the Spring of 1998, has enabled Finlay to improve the flow of
merchandise to Departments and, during the latter part of 1998, enabled
Finlay to reduce payroll and freight costs.
Additionally, since 1994 Finlay has opened nine domestic stand-alone
jewelry outlet stores which provide Finlay with a channel to sell discontinued,
close-out and certain other merchandise.
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
[GRAPHIC OMITTED]
Finlay has structured its relationships with vendors to encourage sharing
of responsibility for marketing and merchandise management. Finlay furnishes to
vendors, through on-line access to Finlay's information systems, the same sales,
stock and gross margin information that is available to Finlay's store group
management and central office for each of the vendor's styles in Finlay's
merchandise assortment. Using this information, vendors are able to participate
in decisions to replenish inventory which has been sold and to return or
exchange slower-moving merchandise. New items are tested in specially selected
"predictor" Departments where sales experience can indicate an item's future
performance in Finlay's other Departments. Management believes that the access
and input which vendors have in the merchandising process results in a better
assortment, timely replenishment, higher turnover and higher sales of inventory,
differentiating Finlay from its competitors.
Since many of the host store groups in which Finlay operates differ in
fashion image and customer demographics, Finlay's flexible approach to
merchandising is designed to complement each host store's own merchandising
philosophy. Finlay emphasizes a "fashion accessory" approach to fine jewelry and
watches, and seeks to provide items that coordinate with the host store's
fashion focus as well as to maintain stocks of traditional and gift merchandise.
Store Relationships
Host Store Relationships. As of January 30, 1999, Finlay operated 1,109
locations (including 12 stand-alone stores) in 31 host store groups, located in
45 states, the District of Columbia, France, England and Germany. By acquiring
Diamond Park in 1997, Finlay added 139 Departments in three host store groups,
located in 19 states. Finlay's largest host store relationship is with May, for
which Finlay has operated Departments since 1948. Finlay operates the fine
jewelry departments in all of May's 390 department stores, including Lord &
Taylor and Filene's. Finlay's second largest host store relationship is with
Federated, for which Finlay has operated Departments since 1983. Finlay operates
Departments in 153 of Federated's 401 department stores, including Rich's and
Burdines. Over the past three years, store groups owned by May and Federated
accounted for an average of 46% and 21%, respectively, of Finlay's annual sales.
Finlay also operates Departments in numerous other host store groups, such
as Belk and the Carson Pirie Scott and Proffitt's divisions of Saks
Incorporated. Management believes that it maintains excellent relations with its
host store groups, 20 of which have had leases with Finlay for more than five
years (representing 79% of Finlay's sales in 1998) and 16 of which have had
leases with Finlay for more than ten years (representing 69% of Finlay's sales
in 1998). As a consequence of the strong and, in many instances, long-term
relationships, host store groups have routinely renewed Finlay's lease
agreements at their renewal dates. Management believes that the majority of its
lease agreements will continue to be renewed routinely.
7
The following table identifies the host store groups in which Finlay
operated Departments at January 30, 1999, 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 international Departments and its domestic and
international stand-alone locations.
Number of
Inception of Departments
Host Store Group/Location Relationship /Stores
- ------------------------- ------------ -----------
May
Robinsons-May.................................. 1948 55
Filene's....................................... 1977 40
Lord & Taylor.................................. 1978 73
Famous Barr/L.S. Ayres......................... 1979 38
Kaufmann's..................................... 1979 48
Foley's........................................ 1986 57
Hecht's/Strawbridge's.......................... 1986 71
Meier & Frank.................................. 1988 8
Total May Departments....................... --- 390
Federated
Rich's/Lazarus/Goldsmith's..................... 1983 69
Burdines....................................... 1992 43
The Bon Marche................................. 1993 19
Stern's........................................ 1994 22
Total Federated Departments................. --- 153
Saks Incorporated
Younkers....................................... 1973 35
Carson Pirie Scott/Bergner's/Boston Store...... 1977 50
Proffitt's..................................... 1991 15
Parisian....................................... 1997 34
Total Saks Incorporated..................... --- 134
Other Domestic Departments
Crowley's/Steinbach (1)........................ 1968 14
Gottschalks.................................... 1969 32
Belk........................................... 1975 55
Liberty House.................................. 1983 12
The Bon-Ton.................................... 1986 42
Elder Beerman.................................. 1992 35
Dillard's...................................... 1997 62
Marshall Field's............................... 1997 21
Total Other Domestic Departments............ --- 273
-----
Total Domestic Departments.................. 950
International Departments (Sonab)
Bazar de L'Hotel de Ville...................... 1994 6
Galeries Lafayette............................. 1994 34
Monoprix/Inno/Baze/Prisunic.................... 1994 50
Nouvelles Galeries............................. 1994 54
Jeanteur....................................... 1996 1
Allders........................................ 1998 1
Beatties....................................... 1998 1
Total International Departments............. --- 147
Stand-Alone Stores
New York Jewelry Outlet........................ 1994 9
New Gold (Sonab)............................... 1994 3
Total Stand-Alone Stores.................... --- 12
-----
Total Departments and Stand-Alone Stores.. 1,109
___________________________ =====
(1) Finlay closed these Departments during February 1999.
8
Terms of Lease Agreements. Finlay's lease agreements typically have an
initial term of one to five years. Finlay has, where possible, entered into
five-year lease agreements and expects to continue this practice. Finlay's lease
agreements generally contain renewal options or provisions for automatic renewal
absent prior notice of termination by either party. Lease renewals are for one
to five year periods. In 1997, Finlay extended its lease agreements with
Federated, including leases for Departments in Burdines, Rich's, Lazarus,
Goldsmith's and The Bon Marche through February 3, 2001, and the lease for
Departments in Stern's through February 1, 2003. Sonab is in the process of
negotiating extensions of its leases for Departments in the Galeries Lafayette,
Nouvelles Galeries and Bazar de L'Hotel de Ville store groups, which leases are
presently scheduled to expire on December 31, 1999. 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 domestic lease agreements generally require host stores to remit
sales proceeds for each month (without regard to whether such sales were cash,
store credit or national credit card) to Finlay approximately three weeks after
the end of such month. During the months of November and December, however, most
domestic host store groups remit to Finlay 75% of the estimated months' sales
prior to or shortly following the end of that month. Finlay's international
lease agreements generally require host stores to remit sales proceeds for each
two-week period (without regard to whether such sales were cash, store credit
card or national credit card) to Finlay approximately two weeks after the end of
such period. 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 made 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. All of the lease agreements
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 domestic lease agreements require
Finlay to provide its employees with salaries and certain benefits comparable to
those received by the host store's employees. Many of Finlay's lease agreements
provide that Finlay may operate the Departments in any new stores opened by the
host store group. In certain instances, Finlay is operating Departments without
written agreements, although the arrangements in respect of such Departments are
generally in accordance with the terms described herein.
In many cases, Finlay is subject to limitations under its lease agreements
which prohibit Finlay from operating Departments for competing host store groups
within a certain geographical radius of the host stores (typically five to ten
miles). Such limitations restrict Finlay from further expansion within areas
where it currently operates Departments, including expansion by possible
acquisitions. Certain domestic lease agreements, however, make an exception for
adding Departments in stores established by groups with which Finlay has a
preexisting lease arrangement. In addition, Finlay has from time to time
obtained the consent of an existing host store group to operate in another host
store group within a prohibited area. For example, May and Federated have
granted consents of this type to Finlay with respect to one another's stores.
Further, Finlay sought and received the consent of certain of its existing host
store groups in connection with the Diamond Park Acquisition. In certain cases,
Finlay has found that, notwithstanding the absence of any geographical
limitation in a lease agreement, it may be limited as a practical matter from
opening Departments for competing host store groups in close proximity to each
other because of the adverse effect such openings might have on its overall host
store group relationships.
9
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.
Departments Opened/Closed. During 1998, Department openings offset by
closings resulted in a net decrease of eight Departments. Included in the
Departments opened and closed in 1998, listed below, are 34 replacement
Departments relating primarily to Dillard's purchase of the Mercantile Stores
and its subsequent sale of certain stores to Finlay's existing host store
groups. With the exception of two Departments opened in new store groups in
England, the remaining 42 openings were all within existing store groups. The
majority of the closings occurred within existing store groups. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--1998 Compared with 1997".
The following table sets forth data regarding the number of Departments and
stand-alone stores which Finlay has operated from the beginning of 1994:
Fiscal Year Ended
------------------------------------------------------------
Jan. 28, Feb. 3, Feb. 1, Jan. 31, Jan. 30,
1995 1996 1997 1998 1999
--------- -------- -------- --------- ----------
Departments/Stores:
Open at beginning of period.................... 757 903 941 939 1,117
Opened during period........................... 159 70 84 188 78
Closed during period........................... (13) (32) (86) (10) (86)
--------- -------- -------- --------- ----------
Open at end of period.......................... 903 941 939 1,117 1,109
--------- -------- -------- --------- ----------
Net increase (decrease)........................ 146 38 (2) 178 (8)
========= ======== ======== ========= ==========
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 May; the
closing or sale by host store groups of individual stores; the closing of
Departments in a host store group as a result of the opening of Departments in
another host store group that competes in the same geographic market; host store
group decisions to consolidate with one lessee; and Finlay's decision to close
unprofitable Departments. To management's knowledge, none of the 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 domestic 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. 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 brand name items or, in some cases, set price minimums
below which Finlay may not sell particular items. Sonab's watch selection is
limited to private label watches marketed under Sonab's "New Gold" and "Gold
Line" names. In France, all other watch brands are sold by the host stores.
10
The following table sets forth the domestic sales and percentage of sales
by category of merchandise for 1996, 1997 and 1998:
Fiscal Year Ended
------------------------------------------------------------------------------------
Feb. 1. 1997 Jan. 31, 1998 Jan. 30, 1999
--------------------------- ------------------------ -------------------------
% of % of % of
Sales Sales Sales Sales Sales Sales
----------- ---------- ---------- ---------- ---------- ----------
(Dollars in millions)
Gemstones................. $ 153.1 24.1% $ 169.0 23.4% $ 184.4 22.4%
Gold...................... 144.8 22.8 155.1 21.6 182.0 22.1
Watches................... 114.3 18.0 126.3 17.6 147.0 17.9
Diamonds.................. 129.2 20.3 147.7 20.5 192.0 23.4
Other (1)................. 93.5 14.8 121.5 16.9 116.6 14.2
----------- ---------- ---------- ---------- ---------- ----------
Total Sales............... $ 634.9 100.0% $ 719.6 100.0% $ 822.0 100.0%
=========== ========== ========== ========== ========== ==========
__________________________
(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 1998, the average price of the items sold by Finlay was approximately
$161 per item. An average Department has over 4,000 items in stock. Consistent
with fine jewelry retailing in general, a substantial portion of Finlay's sales
are made at prices discounted from listed retail prices. Finlay's advertising
and promotional planning are closely coordinated with its pricing strategy.
Publicized sales events are an important part of Finlay's marketing efforts. A
substantial portion of Finlay's sales occur during such promotional events. The
amount of time during which merchandise may be offered at discount prices is
limited by applicable laws and regulations. See "Legal Proceedings".
Purchasing and Inventory
General. A key element of Finlay's strategy has been to lower the working
capital investment required for operating its existing Departments and opening
new Departments. At any one time, Finlay typically is required to pay in advance
of sale for less than half of its inventory because in recent years, on average,
approximately 49% of Finlay's domestic merchandise has been obtained on
consignment and certain additional inventory has been purchased with extended
payment terms. In 1998, Finlay's net monthly investment in inventory (i.e., the
total cost of inventory owned and paid for) averaged 38% of the total cost of
its on-hand merchandise. Finlay is generally granted exchange privileges which
permit Finlay to return or exchange unsold merchandise for new products at any
time. In addition, Finlay structures its relationships with vendors to encourage
their participation in and responsibility for merchandise management. By making
the vendor a participant in Finlay's merchandising strategy, Finlay has created
opportunities for the vendor to assist in identifying fashion trends, thereby
improving inventory turnover and profitability. As a result, Finlay's direct
capital investment in inventory has been reduced to levels which it believes are
low for the retail jewelry industry. In addition, Finlay's inventory exposure to
changing fashion trends is reduced because, in general, unsold consignment
merchandise can be returned to the vendor.
Management believes the willingness of vendors to participate in the
inventory management process is due, in part, to the large volume of merchandise
which Finlay sells in its Departments and the desire of vendors to take
advantage of Finlay's nationwide distribution network. By offering their
merchandise through Finlay's Departments, vendors are able to reach a broad
spectrum of the marketplace in
11
coordination with national or regional advertising campaigns conducted by the
vendors or their service organizations.
In 1998, merchandise obtained by Finlay from its 40 largest vendors (out of
a total of approximately 325 vendors) generated approximately 77% of domestic
sales, and merchandise obtained from Finlay's largest vendor generated
approximately 11% of domestic sales. Finlay does not believe the loss of any one
of its vendors would have a material adverse effect on its business.
In addition, Finlay's new central distribution facility, which became fully
operational in the Spring of 1998, has enabled Finlay to improve the flow of
merchandise to Departments and, during the latter part of 1998, enabled Finlay
to reduce payroll and freight costs.
Gold Consignment Agreement. Finlay Jewelry is party to a gold consignment
agreement (the "Gold Consignment Agreement"), which expires on December 31,
2001. The Gold Consignment Agreement enables Finlay to receive merchandise by
providing gold, or otherwise making payment, to certain vendors who currently
supply Finlay with merchandise on consignment. While the merchandise involved
remains consigned, title to the gold content of the merchandise transfers from
the vendors to the gold consignor. Finlay can obtain, pursuant to the Gold
Consignment Agreement, up to the lesser of (i) 85,000 fine troy ounces or (ii)
$32.0 million worth of gold, subject to a formula as prescribed by the Gold
Consignment Agreement. At January 30, 1999, amounts outstanding under the Gold
Consignment Agreement totaled 78,836 fine troy ounces, valued at approximately
$22.5 million. The average amount outstanding under the Gold Consignment
Agreement was $15.6 million in 1998.
Under the Gold Consignment Agreement, Finlay is required to pay a daily
consignment fee on the dollar equivalent of the fine gold value of the ounces of
gold consigned thereunder. The daily consignment fee is based on a floating rate
which, as of January 30, 1999, was approximately 3.2% per annum. In addition,
Finlay is required to pay an unused line 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 30 and 150 linear feet
of display cases (with an average of approximately 60 linear feet) generally
located in high traffic areas on the main floor of the host stores. Each
Department is supervised by a manager whose primary duties include customer
sales and service, scheduling and training of personnel, maintaining security
controls and merchandise presentation. Most of the Departments utilize up to 260
staff hours per week on a permanent basis, depending on the Department's sales
volume, and employ additional sales staff during the peak year-end holiday
season. Each Department is open for business during the same hours as its host
store. Subject to the terms of the applicable host store group lease agreement,
Finlay is generally responsible for its own operating decisions within each of
its Department operations, including the hiring and compensation of sales staff.
See "--Store Relationships--Terms of Lease Agreements".
To parallel host store operations, Finlay establishes separate group
service organizations responsible for managing Departments operated for each
host store. Staffing for each group organization varies with the number of
Departments in each group. Typically, Finlay services each host store group with
a group manager, an assistant group manager, one or more group buyers, one or
more regional supervisors who oversee the individual Department managers and a
number of clerical employees. Each group manager
12
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, thereby improving
customer service and, as a result, sales. For example, Finlay implemented an
interface between store cash registers and Finlay's central office, which has
reduced administrative time.
Finlay had average sales per linear foot of approximately $11,600 in 1996,
$11,900 in 1997 and $12,100 in 1998. 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
sales per Department of approximately $729,000, $749,000 and $776,000 in 1996,
1997 and 1998, respectively.
Management Information and Inventory Control Systems. Finlay and its
vendors use Finlay'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. For a discussion of certain matters
regarding the year 2000 and Finlay's information technology initiatives, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources".
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 1998, Finlay employed approximately 8,700 persons in the
United States and approximately 600 persons in France, England and Germany,
approximately 90% of whom were regional and local sales and supervisory
personnel and the balance of whom were employed in administrative or executive
capacities. Of Finlay's 8,700 domestic employees, approximately 3,800 were
part-time employees, working less than 20 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 domestic employees are unionized. Substantially
all of Finlay's employees in France are, however, unionized.
Advertising. Finlay promotes its products through four-color direct mail
catalogs, using targeted mailing lists, and newspaper advertising of the host
store groups. Finlay maintains an in-house advertising staff responsible for
preparing a majority of Finlay's advertisements and for coordinating the
finished advertisements with the promotional activities of the host stores.
Finlay's gross advertising expenditures over the past five fiscal years have
consistently been in excess of 6% of sales, a level which is consistent with the
jewelry industry's reliance on promotional efforts to generate sales. The
majority of Finlay's domestic 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.
13
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 1998, inventory shrinkage amounted to approximately 0.8% 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.
Gold Hedging. The cost to Finlay of gold merchandise sold on consignment in
some cases is not fixed until the sale is reported to the vendor or the gold
consignor in the case of merchandise sold pursuant to the Gold Consignment
Agreement. In such cases, the cost of merchandise varies with the price of gold
and Finlay is exposed to the risk of fluctuations in the price of gold between
the time Finlay establishes the advertised or other retail price of a particular
item of merchandise and the date on which the sale of the item is reported to
the vendor. In order to hedge against this risk and to enable Finlay to
determine the cost of such goods prior to their sale, Finlay may elect to fix
the price of gold prior to the sale of such merchandise. Accordingly, Finlay at
times enters into futures contracts, such as options or forwards or a
combination thereof. The value of gold hedged under such contracts represented
less than 1% of Finlay Jewelry's cost of goods sold in 1998. Under such
contracts, Finlay 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. Finlay did not have any open positions
in futures contracts for gold at January 31, 1998 or January 30, 1999.
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. Several of Finlay's competitors are substantially larger and have
greater financial resources than Finlay. 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.
With respect to the operation of Departments in host store groups, Finlay
competes with a limited number of other established Department lessees, such as
J.B. Rudolph, and department store chains. Management believes that competition
for the operation of Departments is based principally on the reputation of the
operator for integrity, the expertise and experience of the operator in offering
an attractive selection of merchandise at competitive prices, and the operator's
ability to generate lease fees for the host stores. See "--Store
Relationships--Terms of Lease Agreements" with respect to certain limitations on
Finlay's ability to compete.
14
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".
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 and 500 Fifth Avenue, New York, New York, Finlay has leased approximately
9,200 square feet under a lease which expires January 31, 2000 and approximately
3,600 square feet under a lease which expires July 31, 2000, respectively.
Finlay also leases retail space for its New York Jewelry Outlet and French
stand-alone stores and office space in France for Sonab's corporate operations.
Generally, as part of Finlay's domestic 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". Domestically, 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. Finlay has received inquiries and has been subject to
investigation from time to time by various states with respect to its compliance
with such regulations. In 1987 and 1989, Finlay entered into consent decrees
with the states of Wisconsin and Georgia, respectively, in connection with
Finlay's past sales discounting and other practices and paid nominal fines to
both states. In addition, one of Finlay's store groups entered into a consent
decree with the state of Oregon in 1988 and two others are subject to standing
injunctions, one issued at the request of the state of California in 1988 and
the other issued at the request of the state of Colorado in 1990, regarding the
sales discounting practices of the host store groups in the respective states.
As a lessee of the host store groups, Finlay is obligated to comply with the
consent decree and injunctions in effect with respect to the host store groups.
Although Finlay receives inquiries from various state authorities from time to
time, management believes it is in substantial compliance with all applicable
federal and state laws 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 1998.
15
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Finlay Jewelry is a wholly owned subsidiary of the Holding Company.
Accordingly, there is no established public trading market for Finlay Jewelry's
common stock.
During 1998, cash dividends of $3.5 million were distributed by Finlay
Jewelry to the Holding Company. The distributions are generally utilized to pay
interest on the Senior Debentures and certain expenses of the Holding Company
such as legal, accounting and directors' fees. Certain restrictive covenants in
the indenture relating to the Senior Notes, the Revolving Credit Agreement and
the Gold Consignment Agreement currently restrict annual distributions from
Finlay Jewelry to the Holding Company to 0.25% of Finlay Jewelry's net sales for
the preceding fiscal year and also allow distributions to the Holding Company to
enable it to make interest payments on the Senior Debentures.
There was one record holder of Finlay Jewelry's common stock at April 23,
1999.
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 and
statement of operations data of Finlay Jewelry at February 1, 1997, January 31,
1998 and January 30, 1999 and for each of the fiscal years then ended were
derived from consolidated financial statements of Finlay Jewelry, which
statements have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in their report included elsewhere herein. The balance
sheet and statement of operations data of Finlay Jewelry at January 28, 1995 and
February 3, 1996 and for each of the fiscal years then ended were derived from
consolidated financial statements of Finlay Jewelry, 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. 28, Feb. 3, Feb. 1, Jan. 31, Jan. 30,
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Statement of Operations Data:
Sales........................................... $ 552,090 $ 654,491 $ 685,274 $ 769,862 $ 863,428
Cost of sales................................... 261,263 314,029 330,300 371,085 421,450
---------- ---------- ---------- ---------- ----------
Gross margin (2)................................ 290,827 340,462 354,974 398,777 441,978
Selling, general and administrative expenses.... 239,281 281,693 289,145 325,752 364,002
Depreciation and amortization................... 8,910 9,659 10,840 12,163 15,672
Management transition and consulting
expense (3)................................... 5,144 - - - -
---------- ---------- ---------- ---------- ----------
Income (loss) from operations................... 37,492 49,110 54,989 60,862 62,304
Other nonrecurring income (4)................... - (5,000) - - -
Interest expense, net........................... 20,927 21,844 22,526 24,413 24,612
Nonrecurring interest associated with
refinancing (5)............................... - - - - 417
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes and
extraordinary charges........................ 16,565 32,266 32,463 36,449 37,275
Provision (benefit) for income taxes............ 8,349 12,527 14,501 15,528 15,323
---------- ---------- ---------- ---------- ----------
Income (loss) before extraordinary charges...... 8,216 19,739 17,962 20,921 21,952
Extraordinary charges from early extinguishment
of debt, net (6)............................. - - - - 4,755
---------- ---------- ---------- ---------- ----------
Net income (loss)............................... $ 8,216 $ 19,739 $ 17,962 $ 20,921 $ 17,197
========== ========== ========== ========== ==========
Operating and Financial Data:
Number of Departments (end of period) (7)........ 903 941 939 1,117 1,109
Percentage increase in sales..................... 9.2% 18.5% 4.7% 12.3% 12.2%
Percentage increase in comparable Department
sales (7)(8)................................... 4.5% 5.7% 5.9% 5.5% 3.9%
Average sales per Department (7) (9)............. $ 674 $ 710 $ 729 $ 749 $ 776
EBITDA (10)...................................... 46,402 58,769 65,829 73,025 77,976
Capital expenditures............................. 11,228 14,933 17,533 19,338 14,874
Cash flows provided from (used in):
Operating activities............................. $ 25,511 $ (4,620) $ 14,197 $ 74,314 $ (13,018)
Investing activities............................. (12,378) (17,157) (18,372) (79,366) (23,134)
Financing activities............................. (11,559) 24,553 (1,024) (2,349) 40,067
17
Fiscal Year Ended (1)
-------------------------------------------------------------------
Jan. 28, Feb. 3, Feb. 1, Jan. 31, Jan. 30,
1995 1996 1997 1998 1999
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Balance Sheet Data-End of Period:
Working capital.................................. $ 26,864 $ 65,309 $ 75,692 $ 65,705 $ 126,723
Total assets..................................... 338,129 393,057 416,808 501,454 541,403
Short-term debt, including current portion of
long-term debt................................. 576 206 2 - -
Long-term debt, excluding current portion........ 135,004 135,002 135,000 135,000 150,000
Series C Preferred Stock......................... 25,428 - - - -
Total stockholders' equity (deficit)............. 27,706 72,387 86,410 101,826 152,083
____________________________
(1) Each of the fiscal years for which information is presented includes 52
weeks except 1995, which includes 53 weeks.
(2) Finlay utilizes the LIFO method of accounting for inventories. If Finlay
had valued inventories at actual cost, as would have resulted from the
specific identification inventory valuation method, the gross margin would
have increased (decreased) as follows: $0.8 million, $0.9 million, $1.9
million, $(2.3) million and $(1.0) million for 1994, 1995, 1996, 1997 and
1998, respectively.
(3) Included in 1994 are compensation and benefits for a former senior
executive totaling $3.1 million as a result of the termination of his
employment agreement and other management transition and consulting expense
totaling $2.0 million.
(4) Included in 1995 are proceeds of $5.0 million from a life insurance policy
Finlay maintained on a senior executive.
(5) As a result of certain call requirements associated with the Old Notes,
Finlay had outstanding, both the new debt and the old debt for a period of
thirty days. 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 $0.4 million.
(6) The extraordinary charges of $8.0 million include $5.4 million for the
redemption premium on the Old Notes and $2.0 million to write off deferred
financing costs associated with the Old Notes. The income tax benefit on
the extraordinary charges totaled $3.2 million.
(7) Includes, beginning in 1994, Departments and stand-alone locations.
(8) Comparable Department sales are calculated by comparing the sales from
Departments open for the same months in the comparable periods.
(9) Average sales per Department is determined by dividing sales by the average
of the number of Departments open at the beginning and at the end of each
period. For 1994, the effect of the acquisition of Sonab, and subsequent
Department openings by Sonab, was prorated in determining average sales per
Department.
(10) EBITDA represents income from operations before depreciation and
amortization expenses. For 1994, EBITDA includes the effect of management
transition and consulting expense totaling $5.1 million described in Note 3
above. Finlay Jewelry 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.
18
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following should be read in conjunction with "Selected Consolidated
Financial Information" and the Consolidated Financial Statements and Notes
thereto included elsewhere in this Form 10-K.
Certain statements under this caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations' constitute "forward-looking
statements" under the Securities Act of 1933, as amended (the "Securities Act'),
and the Securities Exchange Act of 1934, as amended (the 'Exchange Act"). See
"Special Note Regarding Forward-Looking Statements".
General
Since 1995, sales have increased by $208.9 million to $863.4 million, a
compound annual growth rate of 9.7%, while comparable Department sales have
increased by 5.9%, 5.5% and 3.9% in 1996, 1997 and 1998, respectively.
Comparable Department sales include Departments open for the same months during
comparable periods. Domestic comparable Department sales during this same period
increased 6.0%, 5.7% and 5.4%. The increase in total sales during this period is
the result of (i) adding 168 net new Departments and stand-alone stores,
including 139 Departments from the Diamond Park Acquisition, and (ii) increasing
comparable Department sales. Management attributes its comparable Department
sales increases during this period to the following initiatives: (i) introducing
its "Key Item" and "Best Value" merchandising programs, which provide a targeted
assortment of items at competitive prices; (ii) increasing focus on holiday and
event-driven promotions as well as host store marketing programs; (iii)
positioning Finlay's Departments as a "destination location" for fine jewelry;
and (iv) implementing project PRISM (Promptly Reduce Inefficiencies and Sales
Multiply), a program designed to allow Finlay's sales associates more time for
customer sales and service.
Gross margin as a percentage of sales has decreased from 51.8% in 1996 to
51.2% in 1998. This decrease is principally the result of Finlay's "Key Item"
and "Best Value" programs, which produce higher sales volume and a slightly
lower gross margin, on average, than other merchandise, and the integration of
the former Diamond Park Departments at a lower gross margin offset, in 1997 and
1998, by the favorable impact of the LIFO method of inventory.
Selling, general and administrative expenses ("SG&A") as a percentage of
sales was unchanged at 42.2% in 1996 and 1998. Management attributes this to (i)
leveraging operating expenses through higher domestic sales, and (ii) reducing
the level of certain operating expenses through the ongoing implementation of
project PRISM. Offseting this were additional expenses relating to the central
distribution facility during its initial start up phase and expenses associated
with Finlay's year 2000 remediation project. In addition, the leveraging of
operating expenses was negatively impacted as a result of the slowdown of sales
in France in 1998. The components of SG&A include payroll expense, lease fees,
net advertising expenditures and other field and administrative expenses.
As a result of the 1993 Recapitalization and the 1988 Leveraged
Recapitalization (each as defined in Note 1 of Notes to Consolidated Financial
Statements), Finlay Jewelry is highly leveraged and, as such, interest expense
had a significant impact on Finlay Jewelry's results of operations. The
Refinancing resulted in a lower interest rate on the Senior Notes than the
interest rate on the Old Notes. As such, for the 1998 period subsequent to the
retirement of the Old Notes, interest expense has been favorably impacted as
compared to 1997. Finlay also records approximately $3.6 million of goodwill
amortization annually resulting primarily from the 1988 Leveraged
Recapitalization and the Diamond Park Acquisition.
19
Finlay entered the international fine jewelry retailing market in October
1994 by acquiring Sonab, which as of January 30, 1999 operated 147 Departments
and three stand-alone stores, principally in France. In the second quarter of
1998, Sonab began to experience lower sales trends due to the transition from a
promotional pricing strategy to an everyday low price strategy. 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 1998
and is expected to continue at least through the third quarter of 1999.
Diamond Park Acquisition
On October 6, 1997, Finlay completed the acquisition of certain assets of
Diamond Park, a leading operator of Departments, for approximately $63.0
million. By acquiring Diamond Park, Finlay added 139 Departments that, in 1998,
contributed in excess of $100 million in sales and also added new host store
relationships with Marshall Field's, Parisian and Dillard's (formerly the
Mercantile Stores). Management believes that, in addition to increasing sales
volume, the Diamond Park Acquisition will continue to improve Finlay's results
of operations through the leveraging of expenses and the achievement of other
operating synergies.
Results of Operations
The following table sets forth operating results as a percentage of sales
for the periods indicated:
Fiscal Year Ended
------------------------------------------------
Feb. 1, Jan. 31, Jan. 30,
1997 1998 1999
------------ ------------- ------------
Statement of Operations Data:
Sales.................................................... 100.0% 100.0% 100.0%
Cost of sales............................................ 48.2 48.2 48.8
------------ ------------- ------------
Gross margin........................................... 51.8 51.8 51.2
Selling, general and administrative expenses............. 42.2 42.3 42.2
Depreciation and amortization............................ 1.6 1.6 1.8
------------ ------------- ------------
Income (loss) from operations............................ 8.0 7.9 7.2
Interest expense, net.................................... 3.3 3.2 2.8
Nonrecurring interest associated with refinancing (1) - - 0.1
------------ ------------- ------------
Income (loss) before income taxes and extraordinary
charges................................................ 4.7 4.7 4.3
Provision for income taxes............................... 2.1 2.0 1.8
------------ ------------- ------------
Income (loss) before extraordinary charges.............. 2.6 2.7 2.5
Extraordinary charges from early extinquishment of
debt, net (2).......................................... - - 0.6
------------ ------------- ------------
Net income (loss)........................................ 2.6% 2.7% 1.9%
============ ============= ============
Other Supplemental Data:
EBITDA (3)............................................... 9.6% 9.5% 9.0%
_______________________
(1) See Note 5 to "Selected Consolidated Financial Data".
(2) See Note 6 to "Selected Consolidated Financial Data".
(3) EBITDA represents income from operations before depreciation and
amortization expenses. Finlay Jewelry believes EBITDA provides additional
information for determining its ability to meet future debt service
requirements. See Note 10 to "Selected Consolidated Financial Data".
20
1998 Compared with 1997
Sales. Sales increased $93.6 million, or 12.2%, in 1998 compared to 1997.
Comparable Department sales increased 3.9%. Domestic comparable Department sales
increased 5.4%. Management attributes this increase in comparable Department
sales primarily to the "Key Item" and "Best Value" merchandising programs and to
the marketing initiatives discussed above. Sales from the operation of net new
Departments contributed $63.5 million, primarily due to the acquisition of the
former Diamond Park Departments. This increase was offset by the net effect of
new store openings and closings as well as the timing of such Department
openings and closings.
During 1998, Finlay opened 78 Departments and closed 86 Departments. The
Department openings were comprised of the following:
Number of
Departments/
Store Group Stores Reason
- -------------------------------- ------------ --------------------------------
Proffitt's/Parisian/Younkers.... 12 Proffitt's/Parisian/Younkers'
purchase from Dillards.
Famous Barr/L.S. Ayres.......... 8 Famous Barr /L.S. Ayres'
purchase from Dillard's.
Belk............................ 7 Belk's purchase from Dillard's.
Foley's......................... 1 Foley's purchase from Dillard's.
Dillard's....................... 3 Dillard's purchase from Belk.
Monoprix........................ 7 Expansion in France.
Allders......................... 1 New host store in England.
Beatties........................ 1 New host store in England.
Other........................... 38 Department openings within
--- existing store groups.
78
===
The Department closings were comprised of the following:
Number of
Departments/
Store Group Stores Reason
- -------------------------------- ------------ --------------------------------
Mercantile Stores............... 28 Departments sold by Dillard's to
existing Finlay host store
groups subsequent to Dillard's
acquisition of the Mercantile
Stores. Included in openings
above.
Dillard's....................... 5 Previous Dillard's Departments
prior to Dillard's acquisition
of the Mercantile Stores.
Debenhams....................... 7 Mutual agreement to close.
Monoprix........................ 9 Close smaller volume Departments
Other........................... 37 Department closings within
--- existing store groups.
86
===
Gross margin. Gross margin increased by $43.2 million in 1998 compared to
1997, however, as a percentage of sales, gross margin decreased by 0.6%,
primarily due to (i) management's efforts to increase market penetration and
market share through its pricing strategy and (ii) lower gross margins
experienced by the former Diamond Park Departments, particularly as the
merchandise acquired as part of the Diamond Park Acquisition continued to be
sold in 1998. During 1998, Finlay Jewelry benefited from a decrease in the LIFO
provision of $1.0 million, which was lower than the benefit in 1997 of $2.3
million.
21
Selling, general and administrative expenses. SG&A totaled $364.0 million,
an increase of $38.3 million, or 11.7%, in 1998 compared to 1997 due primarily
to payroll expense and lease fees associated with the increase in Finlay
Jewelry's sales. The increased sales generated by the former Diamond Park
Departments and strong domestic comparable Department sales enabled Finlay
Jewelry to leverage administrative and certain other expenses. Offsetting this
were higher than anticipated expenses relating to the central distribution
facility during its initial start up phase and expenses associated with Finlay's
year 2000 remediation project. In addition, the leveraging of operating expenses
was negatively impacted as a result of the slowdown of sales in France. Also, in
1997, Finlay Jewelry purchased inventory from the Holding Company and was
charged a service fee of $1.9 million. As a result of the factors discussed
above, SG&A as a percentage of sales decreased by 0.1% compared to 1997.
Depreciation and amortization. Depreciation and amortization increased by
$3.5 million in 1998 compared to 1997, reflecting $14.9 million in capital
expenditures for the most recent twelve months, depreciation on Finlay's new
central distribution facility and amortization related to the Diamond Park
Acquisition, offset by the effect of certain assets becoming fully depreciated.
The increase in fixed assets was primarily due to the addition of new
Departments and the renovation of existing Departments.
Interest expense, net. Interest expense increased by $0.2 million
reflecting an increase in average borrowings ($272.6 million for 1998 compared
to $242.7 million for 1997). The increase in average borrowings is a result of
an increase in the outstanding balance of the Senior Notes as compared to the
Old Notes and additional indebtedness outstanding under the Revolving Credit
Agreement (adjusted to exclude the timing impact of the call requirements on the
Old Notes, discussed below). The weighted average interest rate was 9.4% for
both 1998 and 1997.
Nonrecurring interest associated with refinancing. As a result of certain
call requirements associated with the Old Notes, the debt could not be repaid
until May 26, 1998. Thus, for thirty days, Finlay was required to maintain as
outstanding both the new debt issued on April 24, 1998 as well as the old debt
retired on May 26, 1998. The net effect of carrying the new and old debt, offset
by reduced interest expense on the borrowings under the Revolving Credit
Agreement and interest income on excess cash balances, was an increase to
interest expense of $0.4 million.
Provision for income taxes. The income tax provision for 1998 and 1997
reflects an effective tax rate of 40.5% and 41.5%, respectively.
Extraordinary charges from early extinguishment of debt, net of income tax
benefit. In conjunction with the repayment of the Old Notes, Finlay Jewelry
recorded a pre-tax extraordinary charge of $8.0 million, including $5.4 million
for the redemption premium on the Old Notes and $2.0 million to write off
deferred financing costs associated the Old Notes. The income tax benefit on the
extraordinary charges totaled $3.2 million.
Net income. Net income of $17.2 million for 1998 represents a decrease of
$3.7 million as compared to net income of $20.9 million in 1997 as a result of
the factors discussed above. Income before extraordinary charges increased by
$1.0 million to $22.0 million in 1998.
1997 Compared with 1996
Sales. Sales increased $84.6 million, or 12.3%, in 1997 compared to 1996.
Comparable Department sales increased 5.5%. Domestic comparable Department sales
increased 5.7%. Management attributes this increase in comparable Department
sales primarily to the "Key Item" and "Best Value" merchandising programs and to
the marketing initiatives discussed above. Sales increased $46.9 million
22
as a result of the net new store openings, primarily due to the acquisition of
the former Diamond Park Departments.
During 1997, Finlay opened 188 Departments and closed ten Departments. The
Department openings were comprised of the following:
Number of
Departments/
Store Group Stores Reason
- ----------------------------- ------------- --------------------------------
Mercantile Stores............ 90 Diamond Park Acquisition.
Marshall Field's............. 21 Diamond Park Acquisition.
Parisian..................... 28 Diamond Park Acquisition.
Monoprix..................... 16 Expansion in France.
Other........................ 33 Department openings within
--- existing store groups.
188
===
These openings were offset by ten Departments closed within existing host
store groups.
Gross margin. Gross margin increased by $43.8 million in 1997 compared to
1996 and, as a percentage of sales, gross margin was unchanged compared to 1996.
During 1997, Finlay Jewelry benefited from a decrease in the LIFO provision as
well as the inclusion of the results of the former Diamond Park Departments,
which contributed $26.4 million to Finlay Jewelry's gross margin, offset by
management's efforts to increase market penetration and market share through its
pricing strategy.
Selling, general and administrative expenses. SG&A totaled $325.8 million,
an increase of $36.6 million, or 12.7%, in 1997 compared to 1996 due primarily
to payroll expense and lease fees associated with the increase in Finlay
Jewelry's sales. As a percentage of sales, SG&A increased by 0.1% in 1997
compared to 1996.
Depreciation and amortization. Depreciation and amortization increased by
$1.3 million in 1997 compared to 1996, reflecting $19.3 million in capital
expenditures for the most recent twelve months, offset by the effect of certain
assets becoming fully depreciated. The increase in fixed assets was primarily
due to the addition of new Departments and the renovation of existing
Departments.
Interest expense, net. Interest expense increased by $1.9 million in 1997
compared to 1996, reflecting an increase in average borrowings ($242.7 million
for 1997 compared to $210.4 million for 1996) primarily as a result of financing
the Diamond Park Acquisition. The increase in average borrowings was partially
offset by a lower weighted average interest rate (9.4% for 1997 compared to 9.7%
for 1996).
Provision for income taxes. The income tax provision for 1997 and 1996
reflects an effective tax rate of 41.5%.
Net income. Net income of $20.9 million for 1997 represents an increase of
$3.0 million as compared to net income of $18.0 million in 1996 as a result of
the factors discussed above.
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 1998, capital
expenditures totaled $14.9 million and in 1997 totaled $19.3 million, which
included construction
23
costs related to Finlay's central distribution facility. Total capital
expenditures for 1999 are estimated to be approximately $15.0 million. Although
capital expenditures are limited by the terms of the RevolvingCredit Agreement,
to date this limitation has not precluded Finlay from satisfying its capital
expenditure requirements.
Finlay's operations substantially preclude customer receivables and in
recent years, on average, approximately 49% 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. Finlay Jewelry's working capital balance was $126.7 million at
January 30, 1999, an increase of $61.0 million from January 31, 1998. The
increase resulted primarily from a capital contribution from the Holding
Company, the sale of the Senior Notes and the impact of 1998's net income
exclusive of depreciation and amortization, partially offset by the use of such
proceeds to prepay the Old Notes and capital expenditures. Based on the seasonal
nature of Finlay's business, working capital requirements and therefore
borrowings under the Revolving Credit Agreement can be expected to increase on
an interim basis during the first three quarters of any given fiscal year. See
"--Seasonality".
The seasonality of Finlay's business causes working capital requirements to
reach their highest level in the months of October, November and December in
anticipation of the year-end holiday season. Accordingly, Finlay experiences
seasonal cash needs as inventory levels peak. The Revolving Credit Agreement
provides Finlay with a line of credit of up to $275.0 million to finance working
capital needs. Amounts outstanding under the Revolving Credit Agreement bear
interest at a rate equal to, at Finlay's option, (i) the Index Rate (as defined
in the Revolving Credit Agreement) plus a margin ranging from zero to 1.0% or
(ii) adjusted LIBOR plus a margin ranging from 1.0% to 2.0%, in each case
depending on the financial performance of Finlay.
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 January 30, 1999 and January 31, 1998 were
zero. The average amounts outstanding under the Revolving Credit Agreement for
1997 and 1998 were $107.7 million and $123.8 million (adjusted for the impact of
the temporary paydown of the revolving credit facility due to certain call
requirements associated with the Old Notes), respectively. The maximum amount
outstanding for 1998 was $176.0 million.
Significant additional working capital has not been required with respect
to the operation of the former Diamond Park Departments because Finlay purchased
the inventory of the Diamond Park Departments. Inventory purchases for the
former Diamond Park Departments will continue to be financed in part by trade
payables combined with an increased utilization of consignment inventory
compared to the amount of consignment merchandise on hand at the time of the
Diamond Park Acquisition. As such, management believes that working capital
requirements for the former Diamond Park Departments have been reduced as
compared to the amount of working capital required at the time of the Diamond
Park Acquisition.
Finlay's long-term needs for external financing will depend on its rate of
growth, the level of internally generated funds and the ability to continue
obtaining substantial amounts of merchandise on advantageous terms, including
consignment arrangements with its vendors. As of January 30, 1999, $283.8
million of consignment merchandise from approximately 300 vendors was on hand as
compared to $219.8 million at January 31, 1998. For 1998, Finlay had an average
balance of consignment merchandise of $268.5 million as compared to an average
balance of $216.5 million in 1997. See "Business--Store Relationships" and
"Business--Purchasing and Inventory".
24
A substantial amount of Finlay's operating cash flow has been used or will
be required to pay, directly or indirectly, interest with respect to the Old
Notes, the Senior Debentures, the Senior Notes and amounts due under the
Revolving Credit Agreement, including the payments required pursuant to the
Balance Reduction Requirement. As of January 30, 1999, Finlay's outstanding
borrowings included a $150.0 million balance under the Senior Notes. On May 1,
1998, the Holding Company prepaid all of the $39.0 million of accreted interest
on the Old Debentures as of such date. The Holding Company exercised its option
to prepay all such accreted interest to take advantage of the resulting tax
benefit relating to the deductibility of such prepayment in 1998. In addition,
on May 26, 1998, Finlay redeemed the outstanding principal amounts, including
associated premiums, of the Old Debentures and the Old Notes. Finlay funded the
prepayment and the redemptions using the proceeds from the sale of the Senior
Debentures, the 1998 Offering and the sale of the Senior Notes, together with
other available funds. In connection with the redemption of the Old Notes,
Finlay Jewelry recorded a pre-tax nonrecurring charge of approximately $8.0
million, including $5.4 million for the redemption premium on the Old Notes and
$2.0 million to write off deferred financing costs associated with the Old
Notes.
Finlay Jewelry is party to the Gold Consignment Agreement, which expires on
December 31, 2001. The Gold Consignment Agreement enables Finlay Jewelry to
receive merchandise by providing gold, or otherwise making payment, to certain
vendors. Finlay Jewelry can obtain, pursuant to the Gold Consignment Agreement,
up to the lesser of (i) 85,000 fine troy ounces or (ii) $32.0 million worth of
gold, subject to a formula as prescribed by the Gold Consignment Agreement. At
January 30, 1999, amounts outstanding under the Gold Consignment Agreement
totaled 78,836 fine troy ounces, valued at approximately $22.5 million. The
average amount outstanding under the Gold Consignment Agreement was $15.6
million in 1998.
Many of Finlay's existing computer systems, software products, other
systems using embedded chips ("non-information technology systems") and third
party systems, accept only two entries in the date field to distinguish the
year. Beginning in the year 2000, these date fields will need to accept four
digit entries, or properly handle two digit entries, to distinguish 21st century
dates from 20th century dates. As a result, Finlay's date critical functions may
be adversely affected unless the computer systems and software products of both
Finlay and significant third parties are or become year 2000 compliant.
A comprehensive plan is being executed to ensure that all systems critical
to the operation of Finlay are year 2000 compliant. The plan is structured into
five primary phases: identification, assessment, remediation, testing and
implementation. Finlay has completed the identification and assessment phases of
all critical components and is in the remediation phase. Finlay expects that the
testing and implementation phases of all internal systems, including its
non-information technology systems, will be completed by August 1999.
Finlay is using, and will continue to use, a combination of internal and
external resources to execute its year 2000 project plan. Finlay has estimated
that the costs related to its year 2000 efforts will total approximately $4.0
million, of which approximately $1.9 million was spent in 1998. Finlay will
incur the balance of these costs during 1999 and will fund such costs through
operating cash flows.
During 1998, Finlay began formal communications with all of its host
stores, vendors and other third parties in an effort to determine the extent to
which Finlay may be vulnerable to the failure of their systems and to obtain
year 2000 compliance certification. To date, none of the third parties that have
responded have raised any year 2000 issues which Finlay believes would have a
material adverse effect on Finlay. Finlay will continue this communication
process during 1999.
25
Management expects that with the successful implementation of the year 2000
project, the year 2000 issue will not pose significant operational problems.
There can be no assurance, however, that Finlay's systems and software will be
rendered year 2000 compliant in a timely manner, or that Finlay will not incur
significant unforeseen additional expenses to ensure such compliance. The
consequences of a disruption of Finlay's operations, whether caused by Finlay's
internal systems or those of any significant third party, could have a material
adverse effect on Finlay Jewelry's financial position or results of operations.
The likely worst case scenario may be an inability to distribute merchandise to
Finlay's Departments and to process its daily business for some period of time.
The lost revenues, if any, resulting from a worst case scenario would depend on
the time period in which the failure goes uncorrected and the difficulty to
remediate such failure.
Management recognizes the importance of developing a contingency plan in
the event of a year 2000 failure, the development of which is in progress and is
expected to be completed by the third quarter of 1999. Finlay is currently
gathering data in an effort to assess the potential effects on Finlay's mission
critical functions of a failure of Finlay's year 2000 plan to be fully effective
and, to the extent deemed appropriate, to address such effects. In addition,
progress reports on the year 2000 project are presented regularly to senior
management and Finlay's Board of Directors.
During 1998, Finlay began several information technology initiatives,
including the design and development of a new merchandising system and the
upgrade of point-of-sale systems and related hardware in the majority of
Finlay's departments. These projects will serve to support future growth of
Finlay as well as provide improved analysis and reporting capabilities and are
expected to be completed in mid-2000. The cost associated with these projects is
estimated to be $11.0 million for software and implementation costs, to be
included in Deferred charges and other assets, and approximately $3.0 million
for hardware and related equipment, to be included as a component of Finlay
Jewelry's capital expenditures and reflected in Fixed assets. At January 30,
1999, approximately $4.1 million was expended and included in Deferred charges
and other assets.
Section 382 of the Internal Revenue Code of 1986, as amended (the "Code')
restricts utilization of net operating loss ("NOLs") carryforwards after an
ownership change exceeding 50%. As a result of the 1993 Recapitalization, a
change in ownership of the Holding 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 Finlay Jewelry's
annual utilization of its NOLs and other carryforwards which requires a deferral
or loss of the utilization of such NOLs or other carryforwards. Finlay Jewelry
had, at October 31, 1998 (Finlay Jewelry's tax year end), a NOL for tax purposes
of approximately $11.5 million which is subject to an annual limit of
approximately $2.0 million per year. However, for financial reporting purposes,
no NOL exists as of January 30, 1999.
From time to time, Finlay enters into futures contracts, such as options or
forwards, based upon the anticipated sales of gold product in order to hedge
against the risk arising from its payment arrangements. Changes in the market
value of futures contracts are accounted for as an addition to or reduction from
the inventory cost. For the year ended January 30, 1999, the gain or loss on
open futures contracts was not material. Finlay Jewelry did not have any open
positions in futures contracts for gold at January 30, 1999. There can be no
assurance that these hedging techniques will be successful or that hedging
transactions will not adversely affect Finlay Jewery's results of operations or
financial position.
Finlay believes that, based upon current operations, anticipated growth,
and availability under the Revolving Credit Agreement, Finlay Jewelry will, for
the foreseeable future, be able to meet its debt service and anticipated working
capital obligations, and to make distributions to the Holding Company sufficient
to permit the Holding 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
26
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
Holding Company to meet their debt service and other obligations. Currently,
Finlay Jewelry's principal financing arrangements restrict annual distributions
from Finlay Jewelry to the Holding Company to 0.25% of Finlay Jewelry's net
sales for the preceding fiscal year and also allow distributions to the Holding
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 $23.4 million and $24.5 million for
1997 and 1998, respectively.
SEASONALITY
Finlay's business is highly seasonal, with a significant portion of its
sales and income from operations generated during the fourth quarter of each
year, which includes the year-end holiday season. The fourth quarter accounted
for an average of 42% of Finlay's sales and 82% of its income from operations
for 1996, 1997 and 1998. 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.
Finlay Jewelry's Sales and Income (loss) from operations for each quarter
of 1996, 1997 and 1998 were as follows:
Fiscal Quarter
---------------------------------------------------------------
First Second Third Fourth
-------------- ------------ ------------ ------------
(dollars in thousands)
1996:
Sales....................................... $ 130,719 $ 137,188 $ 136,140 $ 281,227
Income (loss) from operations............... 596 6,371 4,606 43,416
1997:
Sales....................................... 134,592 148,060 148,770 338,440
Income (loss) from operations............... 1,187 6,838 2,518 50,319
1998:
Sales....................................... 160,992 177,366 165,894 359,176
Income (loss) from operations............... 2,169 6,335 2,061 51,739
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 to differ
materially from those reflected in the forward-looking statements. Factors that
might cause such a difference include, but are not limited to, those discussed
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations", as well as trends in the general economy in the United States
and France, competition in the retail jewelry business, the seasonality of the
retail jewelry business, Finlay Jewelry's ability to increase comparable
Department sales and to open new
27
Departments, Finlay Jewelry's estimate of the cost to address year 2000
compliance issues and the impact on Finlay Jewelry's operations of a year 2000
failure, Finlay Jewelry's dependence on certain host store relationships due to
the concentration of sales generated by such host stores, the availability to
Finlay Jewelry of alternate sources of merchandise supply in the case of an
abrupt loss of any significant supplier, Finlay Jewelry's ability to continue to
obtain substantial amounts of merchandise on consignment, Finlay Jewelry's
dependence on key officers, Finlay Jewelry's ability to integrate future
acquisitions into its existing business, Finlay Jewelry's high degree of
leverage and the availability to Finlay Jewelry of financing and credit on
favorable terms and changes in regulatory requirements which are applicable to
Finlay Jewelry's business.
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. Finlay Jewelry undertakes no obligation to publicly revise
these forward-looking statements to reflect events or circumstances that arise
after the date hereof. In addition to the disclosure contained herein, readers
should carefully review any disclosure of risks and uncertainties contained in
other documents Finlay Jewelry files or has filed from time to time with the
Securities and Exchange Commission (the "Commission") pursuant to the Exchange
Act.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
Finlay Jewelry is exposed to market risk primarily 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, Finlay Jewelry manages exposures through its regular operating and
financing activities. In addition, the majority of Finlay Jewelry's borrowings
are under fixed rate arrangements, as described in Note 4 of Notes to
Consolidated Financial Statements, and as such, there was no material market
risk exposure to Finlay Jewelry's financial position, results of operations or
cash flows as of January 30, 1999.
28
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Finlay Fine Jewelry Corporation
Report of Independent Public Accountants.....................................F-2
Consolidated Statements of Operations for the years ended February 1, 1997,
January 31, 1998 and January 30, 1999.......................................F-3
Consolidated Balance Sheets as of January 31, 1998 and January 30, 1999......F-4
Consolidated Statements of Changes in Stockholder's Equity for the years
ended February 1, 1997, January 31, 1998 and January 30, 1999...............F-5
Consolidated Statements of Cash Flows for the years ended February 1, 1997,
January 31, 1998 and January 30, 1999.......................................F-6
Notes to Consolidated Financial Statements...................................F-7
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There have been no changes in or disagreements with Finlay Jewelry's
accountants on matters of accounting or financial disclosure.
29
PART III
Item 10. Directors and Executive Officers of the Registrant
Set forth below is certain information with respect to each of the current
executive officers and directors of the Holding Company and Finlay Jewelry. Each
of the persons listed as a director is a member of the Board of Directors of
both the Holding Company and Finlay Jewelry.
Name Age Position
- ---------------------------------- ---- --------------------------------
Arthur E. Reiner.................. 58 Chairman of the Board,
President and Chief Executive
Officer of the Holding Company,
Chairman and Chief Executive
Officer of Finlay Jewelry and
Director
Joseph M. Melvin.................. 48 Executive Vice President and Chief
Operating Officer of the Holding
Company and President and Chief
Operating Officer of Finlay
Jewelry
Leslie A. Philip.................. 52 Executive Vice President and Chief
Merchandising Officer of the
Holding Company and Finlay Jewelry
Barry D. Scheckner................ 49 Senior Vice President and Chief
Financial Officer of the Holding
Company and Finlay Jewelry
David B. Cornstein................ 60 Director
Rohit M. Desai.................... 60 Director
James Martin Kaplan............... 54 Director
Thomas H. Lee..................... 55 Director
Norman S. Matthews................ 66 Director
Hanne M. Merriman................. 57 Director
Warren C. Smith, Jr............... 42 Director
The Holding Company, and an affiliate of Thomas H. Lee Company (together
with its affiliate transferees, the "Lee Investors"), partnerships managed by
Desai Capital Management Incorporated (collectively, the "Desai Investors") and
certain members of management (the "Management Stockholders"), together with
certain third parties, are parties to a Stockholders' Agreement (the
"Stockholders' Agreement") which provides, among other things, that all parties
thereto, subject to certain conditions, vote their shares to fix the number of
members of the Board of Directors of the Holding Company at eight and to vote in
favor of six directors who will be nominated as follows: two by the Lee
Investors; one by the Desai Investors; two by Mr. Cornstein (one of whom must be
a management employee of the Holding Company); and one by Mr. Reiner. The
nomination and election of the remaining two directors is not governed by the
Stockholders' Agreement, although the Stockholders' Agreement does require that
such directors not be parties to the Stockholders' Agreement.
Notwithstanding the foregoing, the right of various persons to designate
directors will be reduced or eliminated at such time as they own less than
certain specified percentages of the shares of Common Stock then outstanding. As
a result of the 1998 Offering (as herein defined), the number of directors that
the Lee Investors have the right to nominate was reduced from two to one.
Pursuant to the Stockholders' Agreement (i) Messrs. Lee and Smith were nominated
to the Board of Directors as the designees of the Lee Investors, (ii) Mr. Desai
was nominated by the Desai Investors, (iii) Messrs. Cornstein and