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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended February 1, 2003
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _________ to __________
Commission File Number: 0-25716
FINLAY ENTERPRISES, INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-3492802
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
529 Fifth Avenue New York, NY 10017
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(Address of principal executive offices) (zip code)
212-808-2800
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
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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]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934).
Yes [ X ] No [__]
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant on August 2, 2002 was $125,645,607, based on
the closing price on the Nasdaq National Market for the common stock on such
date. The registrant does not have any nonvoting common equities.
As of April 29, 2003, there were 9,204,408 shares of common stock, par value
$.01 per share, of the registrant outstanding.
Documents incorporated by reference:
Portions of the Company's definitive Proxy Statement, in connection with its
Annual Meeting to be held in June 2003, are incorporated by reference into Part
III. The Company's Proxy Statement will be filed within 120 days after February
1, 2003.
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FINLAY ENTERPRISES, INC
FORM 10-K
FOR THE FISCAL YEAR ENDED FEBRUARY 1, 2003
INDEX
PAGE(S)
PART I
Item 1. Business................................................................................... 3
Item 2. Properties..................................................................................13
Item 3. Legal Proceedings...........................................................................13
Item 4. Submission of Matters to a Vote of Security Holders.........................................14
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters..................................................................................14
Item 6. Selected Consolidated Financial Data........................................................15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................................................19
Item 7A. Quantitative and Qualitative Disclosures about Market Risk..................................29
Item 8. Financial Statements and Supplementary Data.................................................30
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure......................................................30
PART III
Item 10. Directors and Executive Officers of the Registrant..........................................31
Item 11. Executive Compensation......................................................................33
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters............................................................33
Item 13. Certain Relationships and Related Transactions..............................................37
Item 14. Controls and Procedures.....................................................................38
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................39
SIGNATURES ............................................................................................44
CERTIFICATIONS ............................................................................................45
2
PART I
ITEM 1. BUSINESS
THE COMPANY
Finlay Enterprises, Inc., a Delaware corporation (the "Company"), conducts
business through its wholly owned subsidiary, Finlay Fine Jewelry Corporation, a
Delaware corporation, and its wholly owned subsidiaries ("Finlay Jewelry").
References to "Finlay" mean, collectively, the Company and Finlay Jewelry. All
references herein to "Departments" refer to fine jewelry departments operated
pursuant to license agreements or other arrangements with host department
stores.
Finlay is one of the leading retailers of fine jewelry in the United
States. The Company operates leased fine jewelry Departments in major department
stores for retailers such as The May Department Stores Company ("May"),
Federated Department Stores ("Federated"), Belk, the Carson Pirie Scott division
of Saks Incorporated, Marshall Field's and Dillard's. Finlay sells a broad
selection of moderately priced fine jewelry, including necklaces, earrings,
bracelets, rings and watches, and markets these items principally as fashion
accessories with an average sales price of approximately $186 per item. Average
sales per Department were $923,000 in 2002 and the average size of a Department
is approximately 700 square feet.
On a domestic basis, Finlay's sales have increased from $822.0 million in
1998 to $930.7 million in 2002, a compound annual growth rate of 3.2%. Income
from operations before depreciation and amortization expense has increased from
$77.1 million to $80.8 million in the same period. See footnote 7 to "Selected
Consolidated Financial Data" for a reconciliation to the Company's Consolidated
Financial Statements. Finlay has increased in size from 959 locations at the
beginning of 1998 to 1,011 locations at the end of 2002.
As of February 1, 2003, Finlay operated its 1,011 locations in 20 host
store groups, in 45 states and the District of Columbia. Finlay's largest host
store relationship is with May, for which Finlay has operated Departments since
1948. Finlay operates in 440 of May's fine jewelry departments, representing
substantially all of May's department stores. Finlay's second largest host store
relationship is with Federated, for which Finlay has operated Departments since
1983. Finlay operates Departments in 160 of Federated's 463 department stores.
Over the past three years, store groups owned by May and Federated accounted for
an average of 47% and 23%, respectively, of Finlay's sales. Management believes
that it maintains excellent relations with its host store groups, 18 of which
have had leases with Finlay for more than five years (representing 94% of
Finlay's sales in 2002) and 15 of which have had leases with Finlay for more
than ten years (representing 80% of Finlay's sales in 2002).
On January 22, 2003, Finlay Jewelry's revolving credit agreement with
General Electric Capital Corporation ("G.E. Capital") and certain other lenders
was amended and restated (the "Revolving Credit Agreement"). The Revolving
Credit Agreement, which matures in January 2008, provides Finlay Jewelry with a
senior secured revolving line of credit up to $225.0 million (the "Revolving
Credit Facility").
On April 3, 2000, Finlay completed the acquisition of certain assets of
Jay B. Rudolph, Inc. ("J.B. Rudolph") for $20.6 million, consisting primarily of
inventory and fixed assets. By acquiring J.B. Rudolph (the "J.B. Rudolph
Acquisition"), Finlay added 57 Departments and also added new host store
relationships with Bloomingdale's and Dayton's and Hudson's (both now operating
as Marshall Field's).
On January 3, 2000, Societe Nouvelle d'Achat de Bijouterie - S.O.N.A.B.
("Sonab"), the Company's European leased jewelry department subsidiary, sold the
majority of its assets for $9.9 million. After the sale, the buyer operated more
than 80 locations previously included in Sonab's 130-location base in France.
The remaining departments were closed in 1999. The Company recorded a pre-tax
charge in 1999 of $28.6 million for the write-down of assets for disposition and
related closure expenses. In 2002,
3
the Company revised its original estimate of closure expenses to reflect its
remaining liability and, as a result, recorded a gain of $1.4 million, on a
pre-tax basis.
Finlay's fiscal year ends on the Saturday closest to January 31. References
to 2003, 2002, 2001, 2000, 1999 and 1998 relate to the fiscal years ending on
January 31, 2004, February 1, 2003, February 2, 2002, February 3, 2001, January
29, 2000 and January 30, 1999, respectively. Each of the fiscal years includes
52 weeks except 2000, which includes 53 weeks.
Finlay Jewelry was initially incorporated on August 2, 1985 as SL Holdings
Corporation ("SL Holdings"). The Company, a Delaware corporation incorporated on
November 22, 1988, was organized by certain officers and directors of SL
Holdings to acquire certain operations of SL Holdings. In connection with a
reorganization transaction in 1988, which resulted in the merger of a wholly
owned subsidiary of the Company into SL Holdings, SL Holdings changed its name
to Finlay Fine Jewelry Corporation and became a wholly owned subsidiary of the
Company. The Company is a holding company and has no operations of its own. The
primary asset of the Company is the common stock of Finlay Jewelry, which
conducts all of Finlay's operations. The principal executive offices of the
Company are located at 529 Fifth Avenue, New York, New York 10017 and its
telephone number at this address is (212) 808-2800.
GENERAL
OVERVIEW. Host stores benefit from outsourcing the operation of their fine
jewelry departments. By engaging Finlay, host stores gain specialized
managerial, merchandising, selling, marketing, inventory control and security
expertise. Additionally, by avoiding the high working capital investment
typically required of the jewelry business, host stores improve their return on
investment and can potentially increase their profitability.
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 12 months of operation. Finlay further
benefits because net sales proceeds are generally remitted to Finlay by each
host store on a monthly basis with essentially all customer credit risk borne by
the host store.
As a result of Finlay's strong relationships with its vendors, management
believes that the Company's working capital requirements are lower than those of
many other jewelry retailers. In recent years, on average, approximately 50% of
Finlay's 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 $53.2 billion on jewelry
(including both fine and costume jewelry) in the United States in 2002, an
increase of approximately $21.6 billion over 1992, according to the United
States Department of Commerce. In the department store sector in which Finlay
operates, consumers spent $4.1 billion on fine jewelry in 2002. Management
believes that demographic factors such as the maturing of the U.S. population
and an increase in the number of working women have resulted in greater
disposable income, thus contributing to the growth of the fine jewelry retailing
industry. Management also believes that jewelry consumers today increasingly
perceive fine jewelry as a fashion accessory, resulting in purchases which
augment the Company's gift and special occasion sales. Finlay's Departments are
typically located in "high traffic" areas of leading department stores, enabling
Finlay to capitalize on these consumer buying patterns.
GROWTH STRATEGY. Finlay intends to continue to pursue the following key
initiatives to increase sales and earnings:
4
o INCREASE COMPARABLE DEPARTMENT SALES. Finlay's merchandising and marketing
strategy includes emphasizing key merchandise items, increasing focus on
holiday and event-driven promotions, participating in host store marketing
programs and positioning its Departments as a "destination location" for
fine jewelry. Finlay believes that comparable Department sales will
continue to benefit from these strategies. As a result of a challenging
retail environment, Finlay's comparable store sales have slowed in the past
two years, although they have continued to outpace the comparable store
sales of its host stores.
o ADD DEPARTMENTS WITHIN EXISTING HOST STORE GROUPS. Finlay's well
established relationships with many of its host store groups have enabled
the Company to add Departments in new locations opened by existing host
stores. Finlay has operated Departments in May stores since 1948 and
operates in 440 of May's fine jewelry departments, representing
substantially all of May's department stores. Finlay has also operated
Departments in Federated stores since 1983 and operates Departments in 160
of Federated's 463 department stores.
o ESTABLISH NEW HOST STORE RELATIONSHIPS. Finlay has an opportunity to grow
primarily by establishing new relationships with department stores that
presently operate their own fine jewelry departments or have an interest in
opening jewelry departments. Finlay seeks to establish these new
relationships by demonstrating to department store management the potential
for improved financial performance. Through acquisitions, Finlay has added
Marshall Field's, Parisian, Dillard's and Bloomingdale's to its host store
relationships.
o IMPROVE OPERATING LEVERAGE. Finlay seeks to continue to leverage expenses
both by increasing sales at a faster rate than expenses and by reducing its
current level of certain operating expenses. For example, Finlay has
demonstrated that by increasing the selling space (with host store
approval) of certain high volume Departments, incremental sales can be
achieved without having to incur proportionate increases in selling and
administrative expenses. In addition, management believes the Company will
benefit from further investments in technology and refinements of operating
procedures designed to allow Finlay's sales associates more time for
customer sales and service. In March 2002, the Company implemented a new
merchandising and inventory control system and a point-of-sale system for
its Departments. These systems will provide the foundation for future
productivity and expense control initiatives. Further, Finlay's central
distribution facility has enabled the Company to improve the flow of
merchandise to Departments and to reduce payroll and freight costs.
MERCHANDISING STRATEGY. Finlay seeks to maximize sales and profitability
through a unique merchandising strategy known as the "Finlay Triangle", which
integrates store management (including host store management and Finlay's store
group management), vendors and Finlay's central office. By coordinating efforts
and sharing access to information, each Finlay Triangle participant plays a role
which emphasizes its area of expertise in the merchandising process, thereby
increasing productivity. Within guidelines set by the central office, Finlay's
store group management contributes to the selection of the specific merchandise
most appropriate to the demographics and customer tastes within their particular
geographical area. Finlay's advertising initiatives and promotional planning are
closely coordinated with both host store management and Finlay's store group
management to ensure the effective use of Finlay's marketing programs. Vendors
participate in the decision-making process with respect to merchandise
assortment, including the testing of new products, marketing, advertising and
stock levels. By utilizing the Finlay Triangle, opportunities are created for
the vendor to assist in identifying fashion trends thereby improving inventory
turnover and profitability, both for the vendor and Finlay. As a result,
management believes it capitalizes on economies of scale by centralizing certain
activities, such as vendor selection, advertising and planning, while allowing
store management the flexibility to implement merchandising programs tailored to
the host store environments and clientele.
5
THE FINLAY TRIANGLE
---------------
CENTRAL
/ / OFFICE \ \
/ / --------------- \ \
/ / \ \
------------- ---------------
VENDORS - - - - STORE
- - - - MANAGEMENT
------------- ---------------
Finlay has structured its relationships with vendors to encourage sharing
of responsibility for marketing and merchandise management. Finlay furnishes to
vendors, through on-line access to Finlay's information systems, the same sales,
stock and gross margin information that is available to Finlay's store group
management and central office for each of the vendor's styles in Finlay's
merchandise assortment. Using this information, vendors are able to participate
in decisions to replenish inventory which has been sold and to return or
exchange slower-moving merchandise. New items are tested in specially selected
"predictor" Departments where sales experience can indicate an item's future
performance in Finlay's other Departments. Management believes that the access
and input which vendors have in the merchandising process results in a better
assortment, timely replenishment, higher turnover and higher sales of inventory,
differentiating Finlay from its competitors.
Since many of the host store groups in which Finlay operates differ in
fashion image and customer demographics, Finlay's flexible approach to
merchandising is designed to complement each host store's own merchandising
philosophy. Finlay emphasizes a "fashion accessory" approach to fine jewelry and
watches, and seeks to provide items that coordinate with the host store's
fashion focus as well as to maintain stocks of traditional and gift merchandise.
STORE RELATIONSHIPS
HOST STORE RELATIONSHIPS. As of February 1, 2003, Finlay operated 1,011
locations in 20 host store groups, in 45 states and the District of Columbia.
Management believes that it maintains excellent relations with its host store
groups, 18 of which have had leases with Finlay for more than five years
(representing 94% of Finlay's sales in 2002) and 15 of which have had leases
with Finlay for more than ten years (representing 80% of Finlay's sales in
2002). 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.
6
The following table identifies the host store groups in which Finlay
operated Departments at February 1, 2003, 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.
HOST STORE GROUP INCEPTION OF NUMBER
- ---------------- RELATIONSHIP OF DEPARTMENTS
------------ --------------
MAY
Robinsons-May/Meier & Frank.................................... 1948 71
Filene's/Kaufmann's............................................ 1977 95
Lord & Taylor.................................................. 1978 85
Famous Barr/L.S. Ayres/Jones................................... 1979 43
Foley's........................................................ 1986 66
Hecht's/Strawbridge's.......................................... 1986 80
------
Total May Departments...................................... 440
FEDERATED
Rich's/Lazarus/Goldsmith's..................................... 1983 67
Burdines....................................................... 1992 46
The Bon Marche................................................. 1993 21
Bloomingdale's................................................. 2000 26
------
Total Federated Departments................................ 160
SAKS INCORPORATED
Younkers (1)................................................... 1973 33
Carson Pirie Scott/Bergner's/Boston Store...................... 1975 50
Parisian....................................................... 1997 35
Herberger's.................................................... 1999 3
------
Total Saks Incorporated Departments........................ 121
OTHER DEPARTMENTS
Gottschalks.................................................... 1969 38
Belk........................................................... 1975 65
The Bon-Ton.................................................... 1986 43
Elder Beerman.................................................. 1992 35
Dillard's...................................................... 1997 52
Marshall Field's (2)........................................... 1997 57
------
Total Other Departments.................................... 290
------
Total Departments.......................................... 1,011
======
- --------------------
(1) Effective February 2, 2003, Younkers was consolidated into the Carson Pirie
Scott host store group.
(2) Includes the former Dayton's and Hudson's Departments added in 2000 as a
result of the J.B. Rudolph Acquisition.
7
TERMS OF LEASE AGREEMENTS. Finlay's lease agreements typically have an
initial term of one to five years. Finlay has, where possible, entered into
five-year lease agreements. Substantially all of Finlay's lease agreements
contain renewal options or provisions for automatic renewal absent prior notice
of termination by either party. Lease renewals are generally for one to five
year periods. In exchange for the right to operate a Department within the host
store, Finlay pays each host store group a lease fee, calculated as a percentage
of sales (subject to a minimum annual fee in a limited number of cases).
Finlay's lease agreements require host stores to remit sales proceeds for
each month (without regard to whether such sales were cash, store credit or
national credit card) to Finlay approximately three weeks after the end of such
month. However, Finlay cannot ensure the collection of sales proceeds from its
host stores. Additionally, substantially all of Finlay's lease agreements
provide for accelerated payments during the months of November and December,
which require the host store groups to remit to Finlay 75% of the estimated
months' sales prior to or shortly following the end of each such month. Each
host store group withholds from the remittance of sales proceeds a lease fee and
other expenditures, such as advertising costs, which the host store group may
have incurred on Finlay's behalf.
Finlay is usually responsible for providing and maintaining any fixtures
and other equipment necessary to operate its Departments, while the host store
is typically required to provide clean space for installation of any necessary
fixtures. The host store is generally responsible for paying utility costs
(except certain telephone charges), maintenance and certain other expenses
associated with the operation of the Departments. Finlay's lease agreements
typically provide that Finlay is responsible for the hiring (subject to the
suitability of such employees to the host store) and discharge of its sales and
Department supervisory personnel, and substantially all lease agreements require
Finlay to provide its employees with salaries and certain benefits comparable to
those received by the host store's employees. Many of Finlay's lease agreements
provide that Finlay may operate the Departments in any new stores opened by the
host store group. In certain instances, Finlay is operating Departments without
written agreements, although the arrangements in respect of such Departments are
generally in accordance with the terms described herein.
In several cases, Finlay is subject to limitations under its lease
agreements which prohibit Finlay from operating Departments for competing host
store groups within a certain geographical radius of the host stores (typically
five to ten miles). Such limitations restrict Finlay from further expansion
within areas where it currently operates Departments, including expansion by
possible acquisitions. Certain lease agreements, however, make an exception for
adding Departments in stores established by groups with which Finlay has a
preexisting lease arrangement. In addition, Finlay has from time to time
obtained the consent of an existing host store group to operate in another host
store group within a prohibited area. For example, May and Federated have
granted consents of this type to Finlay with respect to one another's stores.
Further, Finlay sought and received the consent of certain of its existing host
store groups in connection with the 1997 acquisition of certain assets of the
Diamond Park Fine Jewelers division of Zale Corporation and the J.B. Rudolph
Acquisition.
CREDIT. Substantially all consumer credit risk is borne by the host store
rather than by Finlay. Purchasers of Finlay's merchandise at a host store are
entitled to the use of the host store's credit facilities on the same basis as
all of the host store's customers. Payment of credit card or check transactions
is generally guaranteed to Finlay by the host store, provided that the proper
credit approvals have been obtained in accordance with the host store's policy.
Accordingly, payment to Finlay in respect of its sales proceeds is generally not
dependent on when, or if, payment is received by the host store.
8
DEPARTMENTS OPENED/CLOSED. During 2002, Department openings offset by
closings resulted in a net increase of five Departments. The openings, which
totaled 21 Departments, and the closings, which totaled 16 Departments, were all
within existing store groups. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--2002 Compared with 2001".
The following table sets forth data regarding the number of domestic
Departments which Finlay has operated from the beginning of 1998:
FISCAL YEAR ENDED
-------------------------------------------------------------
FEB. 1, FEB. 2, FEB. 3, JAN. 29, JAN. 30,
2003 2002 2001 2000 1999
-------- --------- -------- --------- ---------
DEPARTMENTS/STORES:
Open at beginning of year...................... 1,006 1,053 987 959 959
Opened during year............................. 21 33 86 61 68
Closed during year............................. (16) (80) (20) (33) (68)
-------- --------- -------- --------- ---------
Open at end of year............................ 1,011 1,006 1,053 987 959
-------- --------- -------- --------- ---------
Net increase (decrease)........................ 5 (47) 66 28 -
======== ========= ======== ========= =========
For the years presented in the table above, Department closings were
primarily attributable to: ownership changes in host store groups; internal
consolidation within host store groups; the closing or sale by host store groups
of individual stores; host store group decisions to consolidate with one lessee;
and Finlay's decision to close unprofitable Departments. To management's
knowledge, none of the Department closings during the periods presented in the
table above resulted from dissatisfaction of a host store group with Finlay's
performance.
PRODUCTS AND PRICING
Each of Finlay's Departments offers a broad selection of necklaces,
earrings, bracelets, rings and watches. Other than watches, substantially all of
the fine jewelry items sold by Finlay are made from precious metals and many
also contain diamonds or colored gemstones. Finlay also provides jewelry and
watch repair services. Finlay does not carry costume or gold-filled jewelry.
Specific brand identification is generally not important within the fine jewelry
business, except for watches and designer jewelry. With respect to watches,
Finlay emphasizes brand name vendors, including Citizen, Bulova, Movado and
Seiko. Many of Finlay's lease agreements with host store groups restrict Finlay
from selling certain types of merchandise or, in some cases, selling particular
merchandise below certain price points.
The following table sets forth the sales and percentage of sales by category
of merchandise for 2002, 2001 and 2000:
FISCAL YEAR ENDED
--------------------------------------------------------------------------------------
FEB. 1, 2003 FEB. 2, 2002 FEB. 3, 2001
-------------------------- -------------------------- --------------------------
% OF % OF % OF
SALES SALES SALES SALES SALES SALES
----------- ---------- ---------- ----------- ----------- ----------
(DOLLARS IN MILLIONS)
Diamonds.................. $ 263.8 28.3% $ 264.0 27.7% $ 267.7 26.7%
Gold...................... 214.5 23.1 216.1 22.7 222.3 22.2
Gemstones................. 192.9 20.7 201.7 21.2 209.5 21.0
Watches................... 145.8 15.7 152.2 16.0 167.9 16.8
Other (1)................. 113.7 12.2 118.8 12.4 132.7 13.3
----------- ---------- ---------- ----------- ----------- ----------
Total Sales............... $ 930.7 100.0% $ 952.8 100.0% $1,000.1 100.0%
=========== ========== ========== =========== =========== ==========
- ----------------------
(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.
9
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 2002, the average price of items sold by Finlay was approximately
$186 per item. An average Department has over 5,000 items in stock. Consistent
with fine jewelry retailing in general, a substantial portion of Finlay's sales
are made at prices discounted from listed retail prices. Finlay's advertising
and promotional planning are closely coordinated with its pricing strategy.
Publicized sales events are an important part of Finlay's marketing efforts. A
substantial portion of Finlay's sales occur during such promotional events. The
amount of time during which merchandise may be offered at discount prices is
limited by applicable laws and regulations. See "Legal Proceedings".
PURCHASING AND INVENTORY
GENERAL. A key element of Finlay's strategy has been to lower the working
capital investment required for operating its existing Departments and opening
new Departments. In recent years, on average, approximately 50% of Finlay's
merchandise has been obtained on consignment and certain additional inventory
has been purchased with extended payment terms. In 2002, Finlay's net monthly
investment in inventory (i.e., the total cost of inventory owned and paid for)
averaged 33% of the total cost of its on-hand merchandise. Finlay is generally
granted exchange privileges which permit Finlay to return or exchange unsold
merchandise for new products at any time. In addition, Finlay structures its
relationships with vendors to encourage their participation in and
responsibility for merchandise management. By making the vendor a participant in
Finlay's merchandising strategy, Finlay has created opportunities for the vendor
to assist in identifying fashion trends, thereby improving inventory turnover
and profitability. As a result, Finlay's direct capital investment in inventory
has been reduced to levels which it believes are low for the retail jewelry
industry. In addition, Finlay's inventory exposure to changing fashion trends is
reduced because, in general, unsold consignment merchandise can be returned to
the vendor.
Management believes the willingness of vendors to participate in the
inventory management process is due, in part, to the large volume of merchandise
which Finlay sells in its Departments and the desire of vendors to take
advantage of Finlay's nationwide distribution network. By offering their
merchandise through Finlay's Departments, vendors are able to reach a broad
spectrum of the marketplace in coordination with national or regional
advertising campaigns conducted by the vendors or their service organizations.
In 2002, merchandise obtained by Finlay from its 40 largest vendors (out of
a total of approximately 500 vendors) generated approximately 79% of sales, and
merchandise obtained from Finlay's largest vendor generated approximately 10% of
sales. Finlay does not believe the loss of any one of its vendors would have a
material adverse effect on its business.
GOLD CONSIGNMENT AGREEMENT. Finlay Jewelry is party to an amended and
restated gold consignment agreement (as amended, the "Gold Consignment
Agreement"), which enables Finlay Jewelry to receive consignment merchandise by
providing gold, or otherwise making payment, to certain vendors. While the
merchandise involved remains consigned, title to the gold content of the
merchandise transfers from the vendors to the gold consignor. Effective
September 30, 2002, Finlay Jewelry amended the Gold Consignment Agreement to
extend the term to July 31, 2005, and to permit Finlay Jewelry to obtain up to
the lesser of (i) 165,000 fine troy ounces or (ii) $50.0 million worth of gold,
subject to a formula as prescribed by the Gold Consignment Agreement. At
February 1, 2003, amounts outstanding under the Gold Consignment Agreement
totaled 134,785 fine troy ounces, valued at approximately $49.5 million. The
average amount outstanding under the Gold Consignment Agreement was $39.1
million for the fiscal year ended February 1, 2003. In the event this
arrangement is terminated, Finlay Jewelry will be required to return or
repurchase the outstanding gold at the prevailing gold rate in effect on that
date.
10
Under the Gold Consignment Agreement, Finlay Jewelry is required to pay a
daily consignment fee on the dollar equivalent of the fine gold value of the
ounces of gold consigned thereunder. The daily consignment fee is based on a
floating rate which, as of February 1, 2003, was 2.8% per annum. In conjunction
with the Gold Consignment Agreement, Finlay granted to the gold consignor a
first priority perfected lien on, and a security interest in, specified gold
jewelry of participating vendors approved under the Gold Consignment Agreement
and a lien on proceeds and products of such jewelry, subject to the terms of an
intercreditor agreement between the gold consignor and the Revolving Credit
Agreement lenders.
OPERATIONS
GENERAL. Most of Finlay's Departments have between 50 and 150 linear feet
of display cases (with an average of approximately 72 linear feet) generally
located in high traffic areas on the main floor of the host stores. Each
Department is supervised by a manager whose primary duties include customer
sales and service, scheduling and training of personnel, maintaining security
controls and merchandise presentation. Most of the Departments utilize up to 260
staff hours per week on a permanent basis, depending on the Department's sales
volume, and employ additional sales staff during the peak year-end holiday
season. Each Department is open for business during the same hours as its host
store. Subject to the terms of the applicable host store group lease agreement,
Finlay is generally responsible for its own operating decisions within each of
its Department operations, including the hiring and compensation of sales staff.
See "--Store Relationships--Terms of Lease Agreements".
To parallel host store operations, Finlay establishes separate group
service organizations responsible for managing Departments operated for each
host store. Staffing for each group organization varies with the number of
Departments in each group. Typically, Finlay services each host store group with
a group manager, an assistant group manager, one or more group buyers, one or
more regional supervisors who oversee the individual Department managers and a
number of clerical employees. Each group manager reports to a regional vice
president, who is responsible for the supervision of up to six host store
groups. In its continued efforts to improve comparable Department sales through
improved operating efficiency, Finlay has taken steps to minimize administrative
tasks at the Department level, to improve customer service and, as a result,
sales.
Finlay had average sales per linear foot of approximately $12,600 in 2002,
$12,700 in 2001 and $13,600 in 2000. 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 $923,000, $925,000 and $981,000 in 2002,
2001 and 2000, respectively.
MANAGEMENT INFORMATION AND INVENTORY CONTROL SYSTEMS. Finlay and its
vendors use the Company's management information systems to monitor sales, gross
margin and inventory performance by location, merchandise category, style number
and vendor. Using this information, Finlay is able to monitor merchandise trends
and variances in performance and improve the efficiency of its inventory
management. Finlay also measures the productivity of its sales force by
maintaining current statistics for each employee such as sales per hour,
transactions per hour and transaction size. In March 2002, the Company
implemented a new merchandising and inventory control system and a point-of-sale
system for its Departments. These systems will serve to support future growth of
the Company as well as provide improved analysis and reporting capabilities to
facilitate merchandising solutions. Additionally, these systems will provide the
foundation for future productivity and expense control initiatives.
PERSONNEL AND TRAINING. Finlay considers its employees an important
component of its operations and devotes substantial resources to training and
improving the quality of sales and management personnel. Finlay seeks to
motivate its employees by linking a substantial percentage of their compensation
to performance standards. In most cases, individual sales personnel are
compensated on an hourly basis and paid a commission on sales. Department
managers are generally compensated on the
11
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 2002, Finlay employed approximately 6,100 persons of which
approximately 95% were regional and local sales and supervisory personnel and
the balance were employed in administrative or executive capacities. Of Finlay's
6,100 employees, approximately 3,000 were part-time employees, working less than
32 hours per week. Finlay's labor requirements fluctuate because of the seasonal
nature of Finlay's business. See "--Seasonality". Management believes that its
relations with its employees are good. Less than 1% of Finlay's employees are
unionized.
ADVERTISING. Finlay promotes its products through four-color direct mail
catalogs, using targeted mailing lists, and newspaper advertising of the host
store groups. Finlay maintains an in-house advertising staff responsible for
preparing a majority of Finlay's advertisements and for coordinating the
finished advertisements with the promotional activities of the host stores.
Finlay's gross advertising expenditures over the past five fiscal years have
consistently been approximately 6% of sales, a level which is consistent with
the jewelry industry's reliance on promotional efforts to generate sales. The
majority of Finlay's lease agreements with host store groups require Finlay to
expend certain specified minimum percentages of the respective Department's
annual sales on advertising and promotional activities.
INVENTORY LOSS PREVENTION AND INSURANCE. Finlay undertakes substantial
efforts to safeguard its merchandise from loss or theft, including the
installation of safes at each location and the taking of a daily diamond
inventory count. During 2002, inventory shrinkage amounted to approximately 0.7%
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 or the gold consignor. In order to hedge against this risk and to
enable Finlay to determine the cost of such goods prior to their sale, Finlay
may elect to fix the price of gold prior to the sale of such merchandise.
Accordingly, Finlay, at times, enters into futures contracts, such as forwards,
based upon the anticipated sales of gold product in order to hedge against the
risk arising from its payment arrangements. The value of gold hedged under such
contracts represented approximately 6.0% of the Company's cost of goods sold in
2002. Under such contracts, the Company obtains the right to purchase a fixed
number of fine troy ounces of gold at a specified price per ounce for a
specified period. Such contracts typically have durations ranging from one to
nine months and are generally priced at the spot gold price plus an amount based
on prevailing interest rates plus customary transactions costs. When sales of
such merchandise are reported to the consignment vendors and the cost of such
merchandise becomes fixed, Finlay sells its related hedge position. At February
1, 2003, the Company had two open positions in futures contracts for gold
totaling 4,000 fine troy ounces, valued at $1.4 million, which expire during
2003. The fair market value of gold under such contracts was $1.5 million at
February 1, 2003.
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.
12
COMPETITION
Finlay faces competition for retail jewelry sales from national and
regional jewelry chains, other department stores, local independently owned
jewelry stores and chains, specialty stores, mass merchandisers, catalog
showrooms, discounters, direct mail suppliers, televised home shopping and the
internet. Management believes that competition in the retail jewelry industry is
based primarily on the price, quality, fashion appeal and perceived value of the
product offered and on the reputation, integrity and service of the retailer.
See "--Store Relationships--Terms of Lease Agreements" with respect to certain
limitations on Finlay's ability to compete.
SEASONALITY
The retail jewelry business is highly seasonal. See "Selected Consolidated
Financial Data" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations-- Seasonality".
WEBSITE ACCESS TO THE COMPANY'S REPORTS
Finlay's internet website address is www.finlayenterprises.com. The
Company's annual reports on Form 10-K ("Form 10-K"), quarterly reports on Form
10-Q, current reports on Form 8-K and amendments to those reports filed or
furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), are available free of charge through our
website as soon as reasonably practicable after they are electronically filed
with, or furnished to, the Securities and Exchange Commission (the
"Commission"). The reference to the Company's website address does not
constitute incorporation by reference of the information contained on the
website, and the information contained on the website is not part of this
document.
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. Generally, as part of Finlay's lease arrangements, host
stores provide office space to Finlay's host store group management personnel
free of charge.
ITEM 3. LEGAL PROCEEDINGS
From time to time, Finlay is involved in litigation relating to claims
arising out of its operations in the normal course of business. As of April 29,
2003, Finlay is not a party to any legal proceedings that, individually or in
the aggregate, are reasonably expected to have a material adverse effect on
Finlay's business, results of operations, financial condition or cash flows.
However, the results of these matters cannot be predicted with certainty, and an
unfavorable resolution of one or more of these matters could have a material
adverse effect on Finlay's business, results of operations, financial condition
or cash flows.
Commonly in the retail jewelry industry, a substantial amount of
merchandise is sold at a discount to the "regular" or "original" price. Finlay's
experience is consistent with this practice. See "Business-- Products and
Pricing". A number of states in which Finlay operates have regulations which
require retailers who offer merchandise at discounted prices to offer the
merchandise at the "regular" or "original" prices for stated periods of time.
Management believes it is in substantial compliance with all applicable legal
requirements with respect to such practices.
13
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 2002.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock, par value $.01 per share ("Common Stock"), of the Company
is traded on the Nasdaq National Market under the symbol "FNLY". The high and
low sales prices for the Common Stock during 2002 and 2001 were as follows:
FISCAL YEAR ENDED
-------------------------------------------------------
FEBRUARY 1, 2003 FEBRUARY 2, 2002
------------------------ --------------------------
HIGH LOW HIGH LOW
---------- ---------- ----------- -----------
First Quarter................................. $ 14.75 $ 9.31 $ 14.25 $ 9.00
Second Quarter................................ 18.80 12.66 12.92 10.10
Third Quarter................................. 18.99 11.60 13.00 5.45
Fourth Quarter................................ 15.00 10.50 11.11 6.35
The Company has never paid cash dividends on its Common Stock and has no
present intention to pay any cash dividends in the foreseeable future. Certain
restrictive covenants in the indenture relating to Finlay Jewelry's $150.0
million aggregate principal amount of 8 3/8% Senior Notes due May 1, 2008 (the
"Senior Notes") (the "Senior Note Indenture") and the indenture relating to the
Company's $75.0 million aggregate principal amount of 9% Senior Debentures due
May 1, 2008 (the "Senior Debentures") (the "Senior Debenture Indenture", and
collectively with the Senior Note Indenture, the "Senior Indentures"), the
Revolving Credit Agreement and the Gold Consignment Agreement impose limitations
on the payment of dividends by the Company (including Finlay Jewelry's ability
to pay dividends to the Company). See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
During 2002, cash dividends of $15.7 million were distributed by Finlay
Jewelry to the Company. The distributions are generally utilized to pay interest
on the Senior Debentures and certain expenses of the Company, such as legal,
accounting and directors' fees and to purchase Common Stock under the stock
repurchase program described below.
Information regarding the Company's equity compensation plans is set forth
in Item 12 of Part III of this Form 10-K, which information is incorporated
herein by reference.
On December 1, 2000, the Company announced that its Board of Directors had
approved a stock repurchase program to acquire up to $20 million of Common
Stock. The Company may, at the discretion of management, purchase its Common
Stock, from time to time through September 29, 2003 under the stock repurchase
program. The extent and timing of repurchases will depend upon general business
and market conditions, stock prices, availability under the Revolving Credit
Facility, compliance with certain restrictive covenants and its cash position
and requirements going forward. As of February 1, 2003, the Company repurchased
1,332,942 shares for $13.8 million.
As of April 29, 2003, there were 9,204,408 shares of Common Stock
outstanding and approximately 33 record holders of the Common Stock,
including holders who are nominees for an undetermined number of beneficial
owners, estimated to be in excess of 500. The last reported sale price for the
Common Stock on the Nasdaq National Market on April 29, 2003 was $13.31.
14
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 income statement
and balance sheet data for each of the years ended February 1, 2003, February 2,
2002, February 3, 2001, January 29, 2000 and January 30, 1999 have been derived
from the Company's audited Consolidated Financial Statements.
FISCAL YEAR ENDED (1)
---------------------------------------------------------------------------
FEB. 1, FEB. 2, FEB. 3, JAN. 29, JAN. 30,
2003 2002 2001 2000 1999
------------ ---------- ------------- ------------ -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Sales.......................................... $ 930,709 $ 952,789 $ 1,000,120 $ 912,978 $ 863,428
Cost of sales.................................. 450,532 479,255 496,291 449,912 421,450
Cost of sales - Sonab inventory write-down (2). - - - 7,839 -
------------ ---------- ------------- ------------ -----------
Gross margin (3)................................ 480,177 473,534 503,829 455,227 441,978
Selling, general and administrative expenses.... 399,339 394,238 409,994 379,083 364,652
(Credit) charges associated with the
sale and closure of Sonab (2)............... (1,432) - - 20,792 -
Depreciation and amortization................... 17,566 20,089 17,549 16,895 15,672
------------ ---------- ------------- ------------ -----------
Income from operations.......................... 64,704 59,207 76,286 38,457 61,654
Interest expense, net (4)....................... 24,876 26,937 30,057 29,505 33,154
------------ ---------- ------------- ------------ -----------
Income before income taxes, cumulative effect
of accounting change and extraordinary
charges....................................... 39,828 32,270 46,229 8,952 28,500
Provision for income taxes...................... 15,580 13,735 19,708 4,889 11,986
------------ ---------- ------------- ------------ -----------
Income before cumulative effect of accounting
change and extraordinary charges.............. 24,248 18,535 26,521 4,063 16,514
Cumulative effect of accounting change, net (5). 17,209 - - - -
Extraordinary charges from early extinguishment
of debt, net (6).............................. - - - - 7,415
------------ ---------- ------------- ------------ -----------
Net income...................................... $ 7,039 $ 18,535 $ 26,521 $ 4,063 $ 9,099
============ ========== ============= ============ ===========
Net income per share applicable to common shares:
Basic net income per share:
Before cumulative effect of accounting
change and extraordinary charges........ $ 2.58 $ 1.82 $ 2.54 $ 0.39 $ 1.61
Cumulative effect of accounting change $ (1.83) $ - $ - $ - $ -
Extraordinary charges from early
extinguishment of debt................. $ - $ - $ - $ - $ (0.72)
Net income.............................. $ 0.75 $ 1.82 $ 2.54 $ 0.39 $ 0.89
Diluted net income per share:
Before cumulative effect of accounting
change and extraordinary charges..... $ 2.51 $ 1.80 $ 2.52 $ 0.39 $ 1.59
Cumulative effect of accounting change.. $ (1.78) $ - $ - $ - $ -
Extraordinary charges from early
extinguishment of debt............... $ - $ - $ - $ - $ (0.72)
Net income.............................. $ 0.73 $ 1.80 $ 2.52 $ 0.39 $ 0.88
Weighted average number of shares and share
equivalents outstanding (000's):
Basic................................... 9,416 10,180 10,421 10,413 10,229
Diluted................................. 9,683 10,301 10,508 10,504 10,366
15
FISCAL YEAR ENDED (1)
----------------------------------------------------------------------------
FEB. 1, FEB. 2, FEB. 3, JAN 29, JAN. 30,
2003 2002 2001 2000 1999
------------- ---------- ---------- ----------- --------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
PRO FORMA DOMESTIC STATEMENT OF
OPERATIONS DATA (7):
Sales........................................... $ 930,709 $ 952,789 $ 1,000,120 $ 886,223 $ 822,035
EBITDA (8) ..................................... $ 80,838 $ 79,296 $ 93,835 $ 87,159 $ 77,123
Net income...................................... $ 23,396 $ 18,535 $ 26,521 $ 24,616 $ 18,850
Net income per share applicable to common shares:
Basic net income per share.................... $ 2.49 $ 1.82 $ 2.54 $ 2.36 $ 1.84
Diluted net income per share.................. $ 2.42 $ 1.80 $ 2.52 $ 2.34 $ 1.82
OPERATING AND FINANCIAL DATA:
Number of Departments (end of year) (9):
Consolidated................................... 1,011 1,006 1,053 987 1,109
Domestic....................................... 1,011 1,006 1,053 987 959
Percentage increase (decrease) in sales (10)..... (2.3)% (4.7)% 9.5% 5.7% 12.2%
Percentage increase (decrease) in comparable
Department sales (9)(11):
Consolidated................................... 0.1% (3.0)% 2.1% 6.8% 3.9%
Domestic....................................... 0.1% (3.0)% 2.1% 8.1% 5.4%
Average domestic sales per Department (12)....... $ 923 $ 925 $ 981 $ 911 $ 857
EBITDA (8)....................................... 82,270 79,296 93,835 55,352 77,326
Capital expenditures............................. 12,489 13,850 18,118 14,972 14,874
CASH FLOWS PROVIDED FROM (USED IN):
Operating activities............................. $ 45,309 $ 39,209 $ 27,860 $ 38,804 $ 23,121
Investing activities............................. (15,750) (17,432) (30,403) (21,054) (23,134)
Financing activities............................. (9,597) (4,070) (981) 137 3,692
BALANCE SHEET DATA-END OF PERIOD:
Working capital.................................. $ 208,990 $ 202,536 $ 180,274 $ 157,587 $ 147,337
Total assets..................................... 580,485 584,853 604,143 557,042 543,992
Short-term debt, including current portion of
long-term debt................................. - - - - -
Long-term debt................................... 225,000 225,000 225,000 225,000 225,000
Total stockholders' equity....................... 149,036 149,207 134,340 108,800 99,811
---------------------
(1) Each of the fiscal years for which information is presented includes
52 weeks except 2000, which includes 53 weeks.
(2) Included in 1999 are charges associated with the sale and closure of
Sonab totaling $28.6 million. Included in cost of sales is $7.8
million for the write-down of inventory with the balance of $20.8
million recorded as an operating expense. Included in 2002 is a $1.4
million credit which represents a revision of the Company's estimate
of closure expenses to reflect its remaining liability associated with
the closure of Sonab. Refer to Note 13 of Notes to Consolidated
Financial Statements.
(3) Finlay utilizes the LIFO method of accounting for inventories. If
Finlay had valued inventories using the first-in, first-out inventory
valuation method, the gross margin would have increased (decreased) as
follows: $2.3 million, $3.8 million, $1.8 million, $(1.1) million and
$(1.0) million for 2002, 2001, 2000, 1999 and 1998, respectively.
(4) As a result of certain call requirements associated with the
previously outstanding debentures and notes, Finlay had outstanding
both the new debt and the old debt for a period of twenty-five days in
1998. The net effect of the above, offset by reduced interest expense
on the borrowings under the Revolving Credit Agreement and interest
income on excess cash balances, was $0.7 million.
(5) In accordance with the provisions of the Financial Accounting
Standards Board's ("FASB") Emerging Issues Task Force ("EITF") Issue
No. 02-16, "Accounting by a Customer (Including a Reseller) for Cash
Consideration Received from a Vendor" ("EITF 02-16"), the Company
recorded a cumulative effect of accounting change as of February 3,
2002, the date of adoption, that decreased net income for 2002 by
$17.2 million, net of tax, or $1.78 per share, on a diluted basis. The
application of EITF 02-16 changes the Company's accounting treatment
for the recognition of vendor allowances. In 2002, $20.0 million of
vendor allowances has been reflected as a reduction to cost of sales.
In prior years, these allowances were
(footnotes continue on following page)
16
recorded as a reduction to gross advertising expenses and thus
decreased selling, general and administrative expenses ("SG&A"). Refer
to Note 2 of Notes to Consolidated Financial Statements.
(6) The extraordinary charges of $12.2 million include $7.1 million for
redemption premiums on the previously outstanding debentures and notes
and $3.9 million to write off deferred financing costs and debt
discount associated with the previously outstanding debentures and
notes. The income tax benefit on the extraordinary charges totaled
$4.8 million.
(7) The pro forma financial information reflects the Company's domestic
operations only and excludes the operations of Sonab, as well as the
impact of the sale and closure of Sonab. The pro forma financial
information for 2002 excludes the Company's adoption of EITF 02-16,
described in Note 5 above. Additionally, the pro forma financial
information for 1998 excludes (i) the extraordinary charge of $12.2
million, on a pre-tax basis, described in Note 6 above, and (ii) the
interest associated with refinancing, described in Note 4 above. The
pro forma financial information was calculated as follows:
FISCAL YEAR ENDED
-------------------------------------------------------------------------------
FEB. 1, FEB. 2, FEB. 3, JAN. 29, JAN. 30,
2003 2002 2001 2000 1999
--------------- ----------- ------------ ------------ ------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SALES:
Reported sales ................................. $930,709 $952,789 $1,000,120 $ 912,978 $863,428
Less: Sonab sales .............................. - - - (26,755) (41,393)
-------------- ----------- ------------- -------------- ----------
Pro forma sales ................................ $930,709 $952,789 $1,000,120 $ 886,223 $822,035
============== =========== ============= ============== ==========
EBITDA:
Income from operations ......................... $ 64,704 $ 59,207 $ 76,286 $ 38,457 $ 61,654
Add: Depreciation and amortization ............. 17,566 20,089 17,549 16,895 15,672
-------------- ----------- ------------- -------------- ----------
Consolidated EBITDA ............................ 82,270 79,296 93,835 55,352 77,326
Add: Sonab operating loss ...................... - - - 3,808 441
Less: Sonab depreciation and amortization ...... - - - (632) (644)
-------------- ----------- ------------- -------------- ----------
Domestic EBITDA ................................ 82,270 79,296 93,835 58,528 77,123
Add: (Credit) charges associated with sale and
closure of Sonab ......................... (1,432) - - 28,631 -
-------------- ----------- ------------- -------------- ----------
Pro forma EBITDA ............................... $ 80,838 $ 79,296 $ 93,835 $ 87,159 $ 77,123
============== =========== ============= ============== ==========
NET INCOME:
Reported net income ............................ $ 7,039 $ 18,535 $ 26,521 $ 4,063 $ 9,099
Add: Sonab net loss ........................... - - - 3,517 1,936
Add: (Credit) charges associated with sale and
closure of Sonab, net .................... (852) - - 17,036 -
Add: Interest expense, net (4) ................. - - - - 400
Add: Cumulative effect of accounting
change, net ............................. 17,209 - - - -
Add: Extraordinary charges from early
extinguishment of debt, net ............. - - - - 7,415
-------------- ----------- ------------- -------------- ----------
Pro forma net income ........................... $ 23,396 $ 18,535 $ 26,521 $ 24,616 $ 18,850
============== =========== ============= ============== ==========
BASIC NET INCOME PER SHARE:
Reported net income per share .................. $ 0.75 $ 1.82 $ 2.54 $ 0.39 $ 0.89
Add: Sonab net loss ............................ - - - 0.34 0.19
Add: (Credit) charges associated with the sale
and closure of Sonab, net ............... (0.09) - - 1.63 -
Add: Interest expense, net (4) ................. - - - - 0.04
Add: Cumulative effect of accounting
change, net ............................. 1.83 - - - -
Add: Extraordinary charges from early
extinguishment of debt, net ............. - - - - 0.72
-------------- ----------- ------------- -------------- ----------
Pro forma net income per share ................ $ 2.49 $ 1.82 $ 2.54 $ 2.36 $ 1.84
============== =========== ============= ============== ==========
DILUTED NET INCOME PER SHARE:
Reported net income per share .................. $ 0.73 $ 1.80 $ 2.52 $ 0.39 $ 0.88
Add: Sonab net loss ............................ - - - 0.33 0.19
Add: (Credit) charges associated with the sale
and closure of Sonab, net ................ (0.09) - - 1.62 -
Add: Interest expense, net (4) ................. - - - - 0.04
Add: Cumulative effect of accounting
change, net .............................. 1.78 - - - -
Add: Extraordinary charges from early
extinguishment of debt, net .............. - - - - 0.71
-------------- ----------- ------------- -------------- ----------
Pro forma net income per share ................. $ 2.42 $ 1.80 $ 2.52 $ 2.34 $ 1.82
============== =========== ============= ============== ==========
17
The Company believes that the pro forma domestic statement of
operations data presents, on a comparable basis, the Company's
domestic results of operations and provides additional information for
analyzing the Company's operating performance. This presentation
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 ("GAAP"))
for the purpose of analyzing Finlay's operating performance, financial
position and cash flows as this presentation is not defined by GAAP.
Finlay has presented this information, because it is commonly used by
certain investors to compare companies on the basis of consistent
performance.
(8) EBITDA, a non-GAAP financial measure, represents income from
operations before depreciation and amortization expenses and is
calculated as follows:
FISCAL YEAR ENDED
-------------------------------------------------------------------------
FEB. 1, FEB. 2, FEB. 3, JAN. 29, JAN. 30,
2003 2002 2001 2000 1999
------------ ------------- ------------- ----------- -----------
(DOLLARS IN THOUSANDS)
Income from operations............. $ 64,704 $ 59,207 $ 76,286 $ 38,457 $ 61,654
Add: Depreciation and amortization. 17,566 20,089 17,549 16,895 15,672
------------ ------------- ------------- ----------- -----------
EBITDA............................. $ 82,270 $ 79,296 $ 93,835 $ 55,352 $ 77,326
============ ============= ============= =========== ===========
For 1999 and 2002, consolidated EBITDA includes the charges totaling
$28.6 million and the credit totaling $1.4 million, respectively,
associated with the sale and closure of Sonab. The Company believes
EBITDA provides additional information for determining its ability to
meet future debt service requirements. EBITDA should not be construed
as a substitute for income from operations, net income or cash flow
from operating activities (all as determined in accordance with GAAP)
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 to analyze and compare
companies on the basis of operating performance and to determine a
company's ability to service and/or incur debt. Finlay's computation
of EBITDA may not be comparable to similar titled measures of other
companies.
(9) Includes Departments and stand-alone locations.
(10) Excluding sales for the 53rd week of 2000, the percentage increase in
sales for 2000 was 8.8% and the percentage decrease in sales for 2001
was 4.1%.
(11) Comparable Department sales are calculated by comparing the sales from
Departments open for the same months in the comparable periods.
(12) Average domestic sales per Department is determined by dividing
domestic sales by the average of the number of domestic Departments
open at the beginning and at the end of each period.
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 Exchange Act. See "Special Note Regarding Forward-Looking Statements".
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's Consolidated Financial Statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America. These generally accepted accounting principles require management to
make estimates and assumptions that affect certain financial statement accounts
reported and disclosed at the date of the financial statements. Actual results
may differ from those estimates.
Certain of the Company's significant accounting policies are described in
Note 2 of Notes to the Consolidated Financial Statements. The Company believes
that the following discussion addresses the critical accounting policies, which
are those that are most important to the portrayal of the Company's financial
condition and results of operations and require management's most difficult,
subjective or complex judgments. The Company is not aware of any likely events
or circumstances which would result in different amounts being reported that
would materially affect its financial condition or results of operations.
MERCHANDISE INVENTORIES
The Company values its inventories at the lower of cost or market. The cost
is determined by the last-in, first-out method utilizing selected producer price
indices published for jewelry and watches by the Bureau of Labor Statistics.
Factors related to inventories such as future consumer demand and the economy's
impact on consumer discretionary spending, inventory aging, ability to return
merchandise to vendors, merchandise condition and anticipated markdowns are
analyzed to determine estimated net realizable values. An adjustment is recorded
to reduce the LIFO cost of inventories, if required. Any significant
unanticipated changes in the factors above could have a significant impact on
the value of the inventories and the Company's reported operating results.
DERIVATIVE INSTRUMENTS
The Company is exposed to market risk related to changes in the price of
gold and at times enters into futures contracts, such as forwards, to hedge
against the risk of gold price fluctuations. In 2001, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities", which requires that all
derivative instruments be recorded on the balance sheet as either an asset or a
liability measured at its fair value. Accounting for derivative instruments
under this pronouncement did not have a material impact on the Company's
financial condition, results of operations and cash flows for 2002 and 2001.
VENDOR ALLOWANCES
The Company receives allowances from its vendors through a variety of
programs and arrangements, including cooperative advertising. The allowances are
generally intended to offset the Company's costs of promoting, advertising and
selling the vendors' products in its Departments. Vendor allowances are
recognized as a reduction of cost of sales or SG&A when the purpose for which
the vendor funds were
19
intended to be used has been fulfilled. Accordingly, a reduction or increase in
vendor allowances has an inverse impact on cost of sales and/or SG&A.
In March 2003, the EITF finalized Issue No. 02-16, "Accounting by a
Customer (Including a Reseller) for Cash Consideration Received from a Vendor".
EITF 02-16 addresses the accounting treatment for vendor allowances and provides
that cash consideration received from a vendor should be presumed to be a
reduction of the prices of the vendors' product and should therefore be shown as
a reduction in the purchase price of the merchandise. Further, these allowances
should be recognized as a reduction in cost of sales when the related product is
sold. To the extent that the cash consideration represents a reimbursement of a
specific, incremental and identifiable cost, then those vendor allowances should
be used to offset such costs.
In accordance with EITF 02-16, the Company recorded a cumulative effect of
accounting change as of February 3, 2002, the date of adoption, that decreased
net income for 2002 by $17.2 million, net of tax, or $1.78 per share, on a
diluted basis. As of February 3, 2002, deferred vendor allowances totaled (i)
$17,129,000 for owned merchandise, and (ii) $12,306,000 for merchandise received
on consignment. As of February 1, 2003, the Company's fiscal year end, deferred
vendor allowances totaled (i) $18,452,000 for owned merchandise, which is
included as an offset to merchandise inventories on the 2002 Consolidated
Balance Sheet, and (ii) $10,493,000 for merchandise received on consignment,
which is included as deferred income on the 2002 Consolidated Balance Sheet. In
2002, this change resulted in the reclassification of vendor allowances of $20.0
million, which had previously been accounted for as a reduction to SG&A, to now
reduce cost of sales and consequently, increase gross margin. The Company's 2002
unaudited quarterly financial data has been revised to reflect this change in
accounting method. See Note 10 of Notes to Consolidated Financial Statements of
the Company. The adoption of EITF 02-16 is not expected to have a material
impact on the financial position or results of operations of the Company in
2003.
During 2001 and 2000, the Company recorded its vendor allowances as an
offset to gross advertising expenses, which is included in SG&A on the
Consolidated Statements of Operations. For 2001 and 2000, the unaudited pro
forma impact of the adoption of EITF 02-16, as if it had occurred prior to 2000,
was to decrease cost of sales and increase SG&A by $20,374,000 and $23,665,000,
respectively. For both years, net income and net income per share would not have
been materially different.
REVENUE RECOGNITION
The Company recognizes revenue upon the sale of merchandise, either owned
or consigned, to its customers, net of anticipated returns. The provision for
sales returns is based on the Company's historical return rate.
COVENANT REQUIREMENTS
The Company's agreements covering the Revolving Credit Agreement, the Senior
Debentures and the Senior Notes each require that Finlay comply with certain
restrictive and financial covenants. In addition, Finlay Jewelry is party to the
Gold Consignment Agreement, which also contains certain covenants. As of and for
the year ended February 1, 2003, the Company was in compliance with all of its
covenants. Management expects to be in compliance with all of its covenants
through 2003. Because compliance is based, in part, on management estimates and
actual results can differ from those estimates, there can be no assurance that
the Company will be in compliance with the covenants in the future or that the
lenders will waive or amend any of the covenants should the Company be in
violation of any such covenants. The Company believes the assumptions used are
appropriate.
The Revolving Credit Agreement contains customary covenants, including
limitations on, or relating to capital expenditures, liens, indebtedness,
investments, mergers, acquisitions, affiliate transactions, management
compensation and the payment of dividends and other restricted payments. The
Revolving
20
Credit Agreement also contains various financial covenants, including
minimum earnings and fixed charge coverage ratio requirements and certain
maximum debt limitations.
The Senior Indentures contain restrictions relating to, among other
things, the payment of dividends, the making of certain investments or other
restricted payments, the incurrence of additional indebtedness, the creation of
certain liens, entering into transactions with affiliates, the disposition of
certain assets and engaging in mergers and consolidations.
The Gold Consignment Agreement requires Finlay Jewelry to comply with
certain covenants, including restrictions on the incurrence of certain
indebtedness, the creation of liens, engaging in transactions with affiliates
and limitations on the payment of dividends. In addition, the Gold Consignment
Agreement also contains various financial covenants, including minimum earnings
and fixed charge coverage ratio requirements and certain maximum debt
limitations.
EFFECT OF NEW ACCOUNTING STANDARDS
On February 3, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 142 requires that goodwill and intangible assets
with indefinite useful lives are no longer to be amortized but tested for
impairment on an annual basis. The Company has determined that there was no
impairment of goodwill as of February 3, 2002 since the carrying value of the
Company's reporting unit did not exceed its fair value. In making this
assessment, management relied on a number of factors including 2002's operating
results, business plans, economic projections, anticipated future cash flows and
marketplace data. A change in these underlying assumptions may cause a change in
the results of the tests and, as such, could cause fair value to be less than
the carrying value. In such event, Finlay would then be required to record a
charge, which would impact earnings. Finlay will continue to review the carrying
value of goodwill for impairment on an annual basis or more frequently if
circumstances indicate impairment may have occurred. The Company's goodwill
amortization in 2001 and 2000 totaled $3.7 million in each year.
In October 2001, the FASB issued SFAS No. 144, "Accounting for Impairment
or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting
and reporting for the impairment or disposal of long-lived assets. This
statement extends the reporting requirements to include reporting separately as
discontinued operations components of an entity that have either been disposed
of or classified as held-for-sale. The Company adopted the provisions of SFAS
No. 144 in 2002 and the adoption did not have a material impact on the Company's
financial position or results of operations.
ACCOUNTING STANDARDS NOT YET ADOPTED
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement
No. 4, 44, and 64, Amendment of FASB No. 13, and Technical Corrections", which
amends certain existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions. Additionally, the statement provides that gains and losses from debt
extinguishment are not automatically shown as an extraordinary item on a
company's statement of operations. The provisions of SFAS No. 145 are effective
for fiscal years beginning after May 15, 2002. The adoption of SFAS No. 145 is
not expected to have a material impact on the financial position or results of
operations of the Company.
21
RESULTS OF OPERATIONS
The following table sets forth operating results as a percentage of sales
for the periods indicated:
FISCAL YEAR ENDED
------------------------------------------------
FEB. 1, FEB. 2, FEB. 3,
2003 2002 2001
------------ ------------- ------------
STATEMENT OF OPERATIONS DATA:
Sales.................................................... 100.0% 100.0% 100.0%
Cost of sales............................................ 48.4 50.3 49.6
------------ ------------- ------------
Gross margin........................................... 51.6 49.7 50.4
Selling, general and administrative expenses............. 42.9 41.4 41.0
Credit associated with the sale and
closure of Sonab...................................... (0.2) - -
Depreciation and amortization............................ 1.9 2.1 1.8
------------ ------------- ------------
Income from operations................................... 7.0 6.2 7.6
Interest expense, net.................................... 2.7 2.8 3.0
------------ ------------- ------------
Income before income taxes and cumulative
effect of accounting change.......................... 4.3 3.4 4.6
Provision for income taxes............................... 1.7 1.4 2.0
------------ ------------- ------------
Income before cumulative effect of accounting
change............................................... 2.6 2.0 2.6
Cumulative effect of accounting change, net (1).......... 1.8 - -
------------ ------------- ------------
Net income............................................... 0.8% 2.0% 2.6%
============ ============= ============
- --------------------
(1) See Note 5 to "Selected Consolidated Financial Data".
2002 COMPARED WITH 2001
SALES. Sales decreased $22.1 million, or 2.3%, in 2002 compared to 2001.
Comparable Department sales increased 0.1% in 2002, which management attributes
to a continued challenging retail environment. Comparable Department sales
includes sales from Departments open for the same month during comparable
periods. Total sales were negatively impacted by approximately $31.0 million, or
3.3%, as a result of the 2001 closing of three host store groups, offset by the
net effect of new Department openings and closings.
Finlay's merchandising and marketing strategy includes the following
initiatives: (i) emphasizing its "Key Item" and "Best Value" merchandising
programs, which provide a targeted assortment of items at competitive prices;
(ii) increasing focus on holiday and event-driven promotions as well as host
store marketing programs; and (iii) positioning the Company's Departments as a
"destination location" for fine jewelry.
During 2002, Finlay opened 21 Departments within existing store groups,
which included 11 Departments in May. During this period, Finlay closed 16
Departments including five in May and three in Federated.
GROSS MARGIN. Gross margin increased by $6.6 million in 2002 compared to
2001 and, as a percentage of sales, gross margin increased by 1.9%, primarily
due to the Company's adoption of EITF 02-16. The application of EITF 02-16
changes the Company's accounting treatment for the recognition of vendor
allowances. In 2002, $20.0 million of vendor allowances has been reflected as a
reduction to cost of sales based on the sale of the related product. In prior
years, these allowances were recorded as a reduction to gross advertising
expenses and thus decreased SG&A.
22
Excluding the adoption of EITF 02-16, gross margin decreased by $14.0
million in 2002 compared to 2001 and, as a percentage of sales, gross margin
decreased by 0.3%, primarily due to (i) management's continued efforts to
increase market penetration and market share through its pricing strategy and
(ii) the impact of higher gold prices. Offsetting these factors were favorable
physical inventory shortage results and a lower LIFO charge of $2.3 million in
2002 versus $3.8 million in 2001.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A totaled $399.3 million,
an increase of $5.1 million, or 1.3%, in 2002 compared to 2001, primarily due to
the Company's adoption of EITF 02-16 which, as discussed above, resulted in a
$20.0 million increase to SG&A. SG&A as a percentage of sales increased to 42.9%
in 2002 from 41.4% in 2001.
Excluding the adoption of EITF 02-16, SG&A decreased by $14.9 million, or
3.8%, in 2002 compared to 2001 primarily due to payroll expense and lease fees
associated with the decrease in the Company's sales and reduced gross
advertising expenses. Additionally, the Company recorded a $1.8 million
reduction in employee medical benefits expense associated with favorable claims
experience subsequent to a change in medical insurance carriers. SG&A as a
percentage of sales, excluding the adoption of EITF 02-16, decreased to 40.8% in
2002 from 41.4% in 2001.
CREDIT ASSOCIATED WITH THE SALE AND CLOSURE OF SONAB. In 2002, the Company
revised its 1999 estimate of closure expenses to reflect its remaining liability
associated with the closure of Sonab and, as a result, recorded a credit of $1.4
million.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased by
$2.5 million in 2002 compared to 2001, reflecting the discontinuance of goodwill
amortization of $3.7 million and the effect of certain assets becoming fully
depreciated, offset by additional depreciation and amortization as a result of
capital expenditures and capitalized software costs for the most recent 12
months.
INTEREST EXPENSE, NET. Interest expense decreased by $2.1 million
reflecting a lower weighted average interest rate (7.6% for 2002 compared to
7.8% for 2001) and a decrease in average borrowings ($286.2 million for 2002
compared to $305.8 million for 2001).
PROVISION FOR INCOME TAXES. The effective tax rate, before the cumulative
effect of accounting change, decreased to 39.1% in 2002 from 42.6% in 2001,
primarily as a result of the cessation in 2002 of the amortization of
non-deductible goodwill.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAXES. The Company elected
to adopt EITF 02-16 retroactive to the beginning of 2002 and recorded a
cumulative effect after-tax reduction to earnings of $17.2 million. The charge
relates to the deferral of a portion of the Company's previously collected
vendor allowances relating to both owned merchandise and merchandise received on
consignment.
NET INCOME. Net income of $7.0 million for 2002 represents a decrease of
$11.5 million as compared to net income of $18.5 million in 2001 as a result of
the factors discussed above.
2001 COMPARED WITH 2000
SALES. Sales decreased $47.3 million, or 4.7%, in 2001 compared to 2000.
Excluding sales for the 53rd week of 2000, sales decreased 4.1%. Comparable
Department sales decreased 3.0%. Management attributes this decrease in
comparable Department sales primarily to a challenging retail environment and
the extraordinary events of September 11, 2001 and its impact on the economy,
which resulted in reduced consumer discretionary spending. Total sales were
negatively impacted by $17.3 million as a result of the 2001 closing of two host
store groups, offset by the benefit of a full year of sales from the former J.B.
Rudolph departments and the net effect of new Department openings and closings.
23
During 2001, Finlay opened 33 Departments within existing store groups,
which included 22 Departments in May. During this period Finlay closed 80
Departments which were comprised of the following:
NUMBER OF
STORE GROUP DEPARTMENTS REASON
- ----------------------------------- ------------- -----------------------------------------------------------
Stern's......................... 23 Store group was closed by Federated.
Proffitt's...................... 16 Closed smaller Departments and, at the end of 2001,
host store consolidated under one lessee.
Liberty House................... 12 Federated's acquisition of Liberty House.
Dillard's....................... 7 Closed smaller Departments.
Other........................... 22 Department closings within existing store groups.
-----
80
=====
GROSS MARGIN. Gross margin decreased by $30.3 million in 2001 compared to
2000 and, as a percentage of sales, gross margin decreased by 0.7%, primarily
due to (i) management's continued efforts to increase market penetration and
market share through its pricing strategy, (ii) a charge of $3.8 million in the
LIFO provision compared to the prior year's provision of $1.8 million and (iii)
a charge of $1.5 million for the markdown of aged inventory.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A totaled $394.2 million,
a decrease of $15.8 million, or 3.8%, in 2001 compared to 2000 due primarily to
payroll expense and lease fees associated with the decrease in the Company's
sales. SG&A as a percentage of sales increased to 41.4% in 2001 from 41.0% in
2000 as a result of the negative impact of payroll and other expenses as a
percentage of sales due to the lower sales volume.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased by
$2.5 million in 2001 compared to 2000, reflecting $13.9 million in capital
expenditures and an increase in capitalized software costs for the most recent
12 months. Additionally, during 2001, the Company began amortizing the
capitalized software for its new merchandising and point-of-sale systems. These
costs were offset by the effect of certain assets becoming fully depreciated.
INTEREST EXPENSE, NET. Interest expense decreased by $3.1 million
reflecting a lower weighted average interest rate (7.8% for 2001 compared to
8.6% for 2000) and a decrease in average borrowings ($305.8 million for 2001
compared to $321.6 million for 2000).
PROVISION FOR INCOME TAXES. The effective income tax rate for 2001 and 2000
was 42.6%.
NET INCOME. Net income of $18.5 million for 2001 represents a decrease of
$8.0 million as compared to net income of $26.5 million in 2000 as a result of
the factors discussed above.
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 2002 and 2001,
capital expenditures totaled $12.5 million and $13.9 million, respectively.
Total capital expenditures for 2003 are estimated to be approximately $12.0 to
$13.0 million. Although capital expenditures are limited by the terms of the
Revolving Credit Agreement, to date this limitation has not precluded the
Company from satisfying its capital expenditure requirements.
Finlay's operations substantially preclude customer receivables as Finlay's
lease agreements require host stores to remit sales proceeds for each month
(without regard to whether such sales were cash, store credit or national credit
card) to Finlay approximately three weeks after the end of such month. However,
Finlay cannot ensure the collection of sales proceeds from its host stores.
Additionally, on average,
24
approximately 50% of Finlay's merchandise has been carried on consignment. The
Company's working capital balance was $209.0 million at February 1, 2003, an
increase of $6.5 million from February 2, 2002. The increase resulted primarily
from the impact of 2002's net income (exclusive of depreciation and
amortization) partially offset by the adoption of EITF 02-16, capital
expenditures, additions to deferred charges and the purchase of treasury stock.
The seasonality of Finlay's business causes working capital requirements,
and therefore borrowings under the Revolving Credit Agreement, to reach their
highest level in the months of October, November and December in anticipation of
the year-end holiday season. Accordingly, Finlay experiences seasonal cash needs
as inventory levels peak. Additionally, substantially all of Finlay's lease
agreements provide for accelerated payments during the months of November and
December, which require the host store groups to remit to Finlay 75% of the
estimated months' sales prior to or shortly following the end of each such
month. These proceeds result in a significant increase in the Company's cash,
which is used to reduce the Company's borrowings under the Revolving Credit
Agreement. During 2002, by closely monitoring sales and the continued
challenging retail environment, the Company reduced its inventory levels as
compared to 2001. During 2002, the reduced inventory levels favorably impacted
the Company's outstanding borrowings under the Revolving Credit Agreement.
In January 2003, Finlay entered into the Revolving Credit Agreement, which
expires in January 2008. The Revolving Credit Agreement provides Finlay Jewelry
with a line of credit of up to $225.0 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 prime rate plus a margin ranging from zero
to 1.0% or (ii) adjusted Eurodollar rate plus a margin ranging from 1.0% to
2.0%, in each case depending on the financial performance of the Company.
In each year, Finlay is required to reduce the outstanding revolving credit
balance and letter of credit balance under the Revolving Credit Agreement to
$50.0 million or less and $20.0 million or less, respectively, for a 30
consecutive day period (the "Balance Reduction Requirement"). Borrowings under
the Revolving Credit Agreement at February 1, 2003 and February 2, 2002 were
zero. The average amounts outstanding under the Revolving Credit Agreement for
2002 and 2001 were $61.2 million and $80.8 million, respectively. The maximum
amount outstanding for 2002 was $111.4 million, at which point the unused excess
availability was $106.4 million. At February 1, 2003, the Company was in
compliance with all of its covenants under the Revolving Credit Agreement.
Finlay's long-term needs for external financing will depend on its rate of
growth, the level of internally generated funds and the ability to continue
obtaining substantial amounts of merchandise on advantageous terms, including
consignment arrangements with its vendors. At both February 1, 2003 and February
2, 2002, $359.7 million of consignment merchandise from approximately 300
vendors was on hand. For 2002, Finlay had an average balance of consignment
merchandise of $360.5 million as compared to an average balance of $377.4
million in 2001. See "Business--Store Relationships" and "Business--Purchasing
and Inventory".
A significant amount of Finlay's operating cash flow has been used or will
be required to pay interest, directly or indirectly, with respect to the Senior
Debentures, the Senior Notes and amounts due under the Revolving Credit
Agreement, including the payments required pursuant to the Balance Reduction
Requirement. As of February 1, 2003, Finlay's outstanding borrowings were $225.0
million, which included a $75.0 million balance under the Senior Debentures and
a $150.0 million balance under the Senior Notes. At February 1, 2003, the
Company was in compliance with all of its covenants under the Senior Indentures.
The Company may, at the discretion of management, purchase Senior
Debentures and/or Senior Notes from time to time in the open market.
Additionally, beginning on May 1, 2003, the Senior Debentures and Senior Notes
will be redeemable, in whole or in part, at the option of Finlay, at specified
redemption prices plus accrued and unpaid interest, if any, to the date of the
redemption. The extent and timing of any
25
bond repurchases will depend upon general business and market conditions, bond
prices, availability under the Revolving Credit Facility, compliance with
certain restrictive covenants and Finlay's cash position and requirements going
forward.
Effective September 30, 2002, Finlay Jewelry amended the Gold Consignment
Agreement to extend the term to July 31, 2005 and to permit Finlay to obtain up
to the lesser of (i) 165,000 fine troy ounces or (ii) $50.0 million worth of
gold, subject to a formula as prescribed by the Gold Consignment Agreement. At
February 1, 2003, amounts outstanding under the Gold Consignment Agreement
totaled 134,785 fine troy ounces, valued at approximately $49.5 million. The
average amount outstanding under the Gold Consignment Agreement was $39.1
million in 2002. In the event this agreement is terminated, Finlay Jewelry will
be required to return or repurchase the outstanding gold at the prevailing gold
rate in effect on that date. For financial statement purposes, the consigned
gold is not included in merchandise inventories on the Company's Consolidated
Balance Sheets and, therefore, no related liability has been recorded. At
February 1, 2003, Finlay Jewelry was in compliance with all of its covenants
under the Gold Consignment Agreement.
The following tables summarize the Company's contractual and commercial
obligations which may have an impact on future liquidity and the availability of
capital resources, as of February 1, 2003 (dollars in thousands):
PAYMENTS DUE BY PERIOD
-----------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1 YEAR 1 - 3 YEARS 4 - 5 YEARS AFTER 5 YEARS
- ------------------------------- ----------- ------------------ ------------- ------------ ---------------
Senior Notes (due 2008)....... $ 150,000 $ - $ - $ - $ 150,000
Senior Debentures (due 2008).. 75,000 - - - 75,000
Operating leases (1).......... 11,011 1,974 3,925 3,834 1,278
--------- --------- -------- --------- ----------
Total......................... $ 236,011 $ 1,974 $ 3,925 $ 3,834 $ 226,278
========= ========= ======== ========= ==========
- ------------------
(1) Represents future minimum payments under noncancellable operating leases.
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
--------------------------------------------------------------------------------
OTHER COMMERCIAL
COMMITMENTS TOTAL LESS THAN 1 YEAR 1 - 3 YEARS 4 - 5 YEARS AFTER 5 YEARS
- ------------------------------- ----------- ------------------ ------------- ------------ ---------------
Revolving Credit
Agreement (due 2008) (1) .. $ - $ - $ - $ - $ -
Gold Consignment
Agreement (due 2005) (2).... 49,500 49,500 - - -
Letters of credit.............. 7,250 7,000 - - 250
------- ------- --------- -------- ---------
Total ......................... $56,750 $56,500 $ - $ - $ 250
======= ======= ========= ======== =========
- -------------------
(1) There were no borrowings under the Revolving Credit Agreement at February
1, 2003. The average amount outstanding during 2002 was $61.2 million and
the outstanding balance as of April 29, 2003 was $25.9 million.
(2) Represents amount outstanding at February 1, 2003.
Finlay believes that, based upon current operations, anticipated growth,
and continued availability under the Revolving Credit Agreement, Finlay Jewelry
will, for the foreseeable future, be able to meet its debt service and
anticipated working capital obligations, and to make distributions to the
Company sufficient to permit the Company to meet its debt service obligations
and to pay certain other expenses as they come due. No assurances, however, can
be given that Finlay Jewelry's current level of operating results will continue
or improve or that Finlay Jewelry's income from operations will continue to be
sufficient to permit Finlay Jewelry and the Company to meet their debt service
and other obligations. Currently, Finlay Jewelry's principal financing
arrangements restrict annual distributions from Finlay
26
Jewelry to the Company to 0.25% of Finlay Jewelry's net sales for the preceding
fiscal year and also allow distributions to the Company to enable it to make
interest payments on the Senior Debentures. Other dividends and distributions,
including those required to fund stock or bond repurchases, are subject to
Finlay's satisfaction of certain restrictive covenants. The amounts required to
satisfy the aggregate of Finlay Jewelry's interest expense totaled $16.8 million
and $19.0 million for 2002 and 2001, respectively.
The Company has an employment agreement with one senior executive which
provides for a minimum salary level as well as incentive compensation based on
meeting specific financial goals. Such agreement has a remaining term of two
years and has a remaining aggregate minimum value of $1,975,000 as of February
1, 2003.
In December 2000, the Company announced that its Board of Directors had
approved a stock repurchase program to acquire up to $20 million of outstanding
Common Stock. The Company may, at the discretion of management, purchase its
Common Stock, from time to time through September 29, 2003 under the stock
repurchase program. The extent and timing of repurchases will depend upon
general business and market conditions, stock prices, availability under the
Revolving Credit Facility, compliance with certain restrictive covenants and its
cash position and requirements going forward. As of February 1, 2003, the
Company repurchased 1,332,942 shares for $13.8 million.
In March 2002, the Company implemented a new merchandising and inventory
control system and a point-of-sale system for its Departments. These systems
will serve to support future growth of the Company as well as provide improved
analysis and reporting capabilities and more timely sales and inventory
information to facilitate merchandising solutions. Additionally, these systems
will provide the foundation for future productivity and expense control
initiatives. At February 1, 2003, a total of $22.1 million has been expended for
software and implementation costs and is included in Deferred charges and other
assets.
From time to time, Finlay enters into futures contracts, such as forwards,
based upon the anticipated sales of gold product in order to hedge against the
risk arising from its payment arrangements. At February 1, 2003, the Company had
two open positions in futures contracts for gold, which expire during 2003,
totaling 4,000 fine troy ounces, valued at $1.4 million. There can be no
assurance that these hedging techniques will be successful or that hedging
transactions will not adversely affect the Company's results of operations or
financial position.
In February 2001, Federated announced its plans to close its Stern's
division in which Finlay operated 23 departments. Finlay closed the majority of
the Stern's departments during the second quarter of 2001. Subsequently,
Federated converted the majority of the Departmen