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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 January 31, 2004
--- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
--------- ----------
Commission File Number: 33-59380
FINLAY FINE JEWELRY CORPORATION
-------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3287757
- ------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
529 Fifth Avenue New York, NY 10017
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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: None
------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X* No
---- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [x]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
As of April 9, 2004, there were 1,000 shares of common stock, par value $.01 per
share, of the registrant outstanding. As of such date, all shares of common
stock were owned by the registrant's parent, Finlay Enterprises, Inc., a
Delaware corporation.
*The registrant is not subject to the filing requirements of Section 13 or 15(d)
of the Securities Exchange Act of 1934 and is voluntarily filing this Annual
Report on Form 10-K.
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FINLAY FINE JEWELRY CORPORATION
FORM 10-K
FOR THE FISCAL YEAR ENDED JANUARY 31, 2004
INDEX
PAGE(S)
PART I
Item 1. Business......................................................... 3
Item 2. Properties.......................................................12
Item 3. Legal Proceedings................................................13
Item 4. Submission of Matters to a Vote of Security Holders..............13
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...........................17
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.......33
Item 8. Financial Statements and Supplementary Data......................34
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...........................34
Item 9A. Controls and Procedures..........................................34
PART III
Item 10. Directors and Executive Officers of the Registrant...............35
Item 11. Executive Compensation...........................................38
Item 12. Security Ownership of Certain Beneficial Owners and Management ..47
Item 13. Certain Relationships and Related Transactions...................50
Item 14. Principal Accountant Fees and Services...........................52
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K......................................................52
SIGNATURES ..............................................................59
2
PART I
ITEM 1. BUSINESS
THE COMPANY
Finlay Fine Jewelry Corporation, a Delaware corporation, and its
wholly-owned subsidiaries ("Finlay Jewelry") is a wholly-owned subsidiary of
Finlay Enterprises, Inc., a Delaware corporation (the "Holding Company").
References to "Finlay" mean, collectively, the Holding Company 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. Finlay 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 $191 per item. Average
sales per Department were $932,000 in 2003 and the average size of a Department
is approximately 700 square feet.
As of January 31, 2004, Finlay operated its 972 locations in 17 host store
groups, in 46 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 441 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 116 of Federated's 459 department stores.
Over the past three years, store groups owned by May and Federated accounted for
an average of 51% and 18%, respectively, of Finlay's sales. Management believes
that it maintains excellent relations with its host store groups, 16 of which
have had leases with Finlay for more than five years (representing 92% of
Finlay's sales in 2003) and 13 of which have had leases with Finlay for more
than ten years (representing 78% of Finlay's sales in 2003).
During 2003, Federated announced that it would not renew Finlay's lease in
the Burdines department store division due to the planned consolidation of the
Burdines and Macy's fine jewelry departments in 2004. The termination of the
lease in January 2004 resulted in the closure of 46 Finlay Departments in the
Burdines department store division and the results of operations for these
Departments have been reclassified as discontinued operations for all periods
presented. In 2003, Finlay generated approximately $55 million in sales from the
Burdines Departments. Additionally, in 2003, May announced its intention to
divest 32 Lord & Taylor stores as well as two other stores in its Famous-Barr
division, resulting in the closure of eight Departments in 2003 and six
Departments during the first quarter of 2004. In 2003, Finlay generated
approximately $20 million in sales from these 34 Departments. At this time, May
has not announced a specific timeline for the closure of the remaining stores.
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").
Finlay's fiscal year ends on the Saturday closest to January 31. References
to 2004, 2003, 2002, 2001, 2000 and 1999 relate to the fiscal years ending on
January 29, 2005, January 31, 2004, February 1, 2003, February 2, 2002, February
3, 2001 and January 29, 2000, 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 Holding Company, a Delaware corporation
incorporated on November 22, 1988, was
3
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 Holding
Company into SL Holdings, SL Holdings changed its name to Finlay Fine Jewelry
Corporation and became a wholly-owned subsidiary of the Holding Company. The
principal executive offices of Finlay Jewelry are located at 529 Fifth Avenue,
New York, New York 10017 and its telephone number at this address is (212)
808-2800.
GENERAL
OVERVIEW. Host stores benefit from outsourcing the operation of their fine
jewelry departments. By engaging Finlay, host stores gain specialized
managerial, merchandising, selling, marketing, inventory control and security
expertise. Additionally, by avoiding the high working capital investment
typically required of the jewelry business, host stores improve their return on
investment and can potentially increase their profitability.
As a lessee, Finlay benefits from the host stores' reputation, customer
traffic, advertising, credit services and established customer base. Finlay also
avoids the substantial capital investment in fixed assets typical of stand-alone
retail formats. These factors have generally enabled Finlay's new Departments to
achieve profitability within their first twelve months of operation. Finlay
further benefits because net sales proceeds are generally remitted to Finlay by
each host store on a monthly basis with essentially all customer credit risk
borne by the host store.
As a result of Finlay's strong relationships with its vendors, management
believes that Finlay Jewelry's working capital requirements are lower than those
of many other jewelry retailers. In recent years, on average, approximately 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 $54.0 billion on jewelry
(including both fine and costume jewelry) in the United States in 2003, an
increase of approximately $19.9 billion over 1993, according to the United
States Department of Commerce. In the department store sector in which Finlay
operates, consumers spent an estimated $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 Finlay's gift and special occasion sales. Finlay's
Departments are typically located in "high traffic" areas of leading department
stores, enabling Finlay to capitalize on these consumer buying patterns.
GROWTH STRATEGY. Finlay intends to continue to pursue the following key
initiatives to increase sales and earnings:
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. Over the past decade, Finlay has
experienced comparable store sales increases (in nine out of ten years) and
has consistently outperformed its host store groups with respect to these
increases.
o ADD DEPARTMENTS WITHIN EXISTING HOST STORE GROUPS. Finlay's well
established relationships with many of its host store groups have enabled
Finlay to add Departments in new locations opened by existing host stores.
Finlay has operated Departments in May stores since 1948 and operates in
4
441 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 116 of Federated's 459
department stores.
o ESTABLISH NEW HOST STORE RELATIONSHIPS. Finlay has an opportunity to grow
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 Finlay 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, Finlay 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 Finlay 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. Finlay's relations with its host store groups, 16
of which have had leases with Finlay for more than five years (representing 92%
of Finlay's sales in 2003) and 13 of which have had leases with Finlay for more
than ten years (representing 78% of Finlay's sales in 2003) provide strong and,
in many instances, long-term relationships such that lease agreements are
routinely renewed. 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 January 31, 2004, 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 OF
- ---------------- RELATIONSHIP DEPARTMENTS
------------ -----------
MAY
Robinsons-May/Meier & Frank........................................ 1948 72
Filene's/Kaufmann's................................................ 1977 99
Lord & Taylor...................................................... 1978 78
Famous Barr/L.S. Ayres/Jones....................................... 1979 43
Foley's............................................................ 1986 69
Hecht's/Strawbridge's.............................................. 1986 80
--
Total May Departments.......................................... 441
FEDERATED
Rich's/Lazarus/Goldsmith's......................................... 1983 65
The Bon Marche..................................................... 1993 22
Bloomingdale's..................................................... 2000 29
--
Total Federated Departments.................................... 116
SAKS INCORPORATED
Carson Pirie Scott/Bergner's/Boston Store/Younkers/Herberger's..... 1973 84
Parisian........................................................... 1997 35
--
Total Saks Incorporated Departments............................ 119
OTHER DEPARTMENTS
Gottschalks........................................................ 1969 38
Belk............................................................... 1975 65
The Bon-Ton........................................................ 1986 44
Elder Beerman...................................................... 1992 34
Dillard's.......................................................... 1997 61
Marshall Field's................................................... 1997 54
--
Total Other Departments........................................ 296
---
Total Departments.............................................. 972
===
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 its past acquisitions.
CREDIT. Substantially all consumer credit risk is borne by the host store
rather than by Finlay. Purchasers of Finlay's merchandise at a host store are
entitled to the use of the host store's credit facilities on the same basis as
all of the host store's customers. Payment of credit card or check transactions
is generally guaranteed to Finlay by the host store, provided that the proper
credit approvals have been obtained in accordance with the host store's policy.
Accordingly, payment to Finlay in respect of its sales proceeds is generally not
dependent on when, or if, payment is received by the host store.
DEPARTMENTS OPENED/CLOSED. During 2003, Department openings offset by
closings resulted in a net decrease of 39 Departments. The openings, which
totaled 32 Departments, were all within existing store groups. The closings
totaled 71 Departments and included 46 Departments as a result of Federated's
decision not to renew Finlay's lease in the Burdines department store division
and eight Lord & Taylor Departments as a result of May's decision to close these
smaller, less profitable locations. The balance of the closings were within
existing store groups. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--2003 Compared with 2002".
8
The following table sets forth data regarding the number of domestic
Departments which Finlay has operated from the beginning of 1999:
FISCAL YEAR ENDED
-------------------------------------------------------------
JAN. 31, FEB. 1, FEB. 2, FEB. 3, JAN. 29,
2004 2003 2002 2001 2000
-------- --------- -------- --------- ---------
DEPARTMENTS/STORES:
Open at beginning of year...................... 1,011 1,006 1,053 987 959
Opened during year............................. 32 21 33 86 61
Closed during year............................. (71) (16) (80) (20) (33)
-------- --------- -------- --------- ---------
Open at end of year............................ 972 1,011 1,006 1,053 987
-------- --------- -------- --------- ---------
Net increase (decrease)........................ (39) 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 2003, 2002 and 2001:
FISCAL YEAR ENDED
----------------------------------------------------------------------------------------
JAN. 31, 2004 FEB. 1, 2003 FEB. 2, 2002
-------------------------- -------------------------- ----------------------------
% OF % OF % OF
SALES SALES SALES SALES SALES SALES
----------- ---------- ---------- ----------- ----------- ------------
(DOLLARS IN MILLIONS)
Diamonds.................. $ 275.2 30.5% $ 250.9 28.6% $ 249.5 27.7%
Gold...................... 199.5 22.1 201.4 23.0 204.3 22.7
Gemstones................. 182.3 20.2 182.4 20.8 190.7 21.2
Watches................... 134.0 14.8 134.3 15.3 143.9 16.0
Other (1)................. 111.4 12.4 108.3 12.3 112.2 12.4
----------- ---------- ---------- ----------- ----------- ------------
Total Sales............... $ 902.4 100.0% $ 877.3 100.0% $ 900.6 100.0%
=========== ========== ========== =========== =========== ============
- ------------
(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.
Finlay sells its merchandise at prices generally ranging from $50 to
$1,000. In 2003, the average price of items sold by Finlay was approximately
$191 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
9
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 2003, Finlay's net monthly
investment in inventory (i.e., the total cost of inventory owned and paid for)
averaged 34% of the total cost of its on-hand merchandise. Finlay is generally
granted exchange privileges which permit Finlay to return or exchange unsold
merchandise for new products at any time. In addition, Finlay structures its
relationships with vendors to encourage their participation in and
responsibility for merchandise management. By making the vendor a participant in
Finlay's merchandising strategy, Finlay has created opportunities for the vendor
to assist in identifying fashion trends, thereby improving inventory turnover
and profitability. As a result, Finlay's direct capital investment in inventory
has been reduced to levels which it believes are low for the retail jewelry
industry. In addition, Finlay's inventory exposure to changing fashion trends is
reduced because, in general, unsold consignment merchandise can be returned to
the vendor.
In 2003, merchandise obtained by Finlay from its 40 largest vendors (out of
a total of approximately 500 vendors) generated approximately 80% 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. Finlay Jewelry's
Gold Consignment Agreement matures on July 31, 2005, and permits Finlay Jewelry
to consign 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 January 31, 2004, amounts outstanding under the Gold
Consignment Agreement totaled 116,835 fine troy ounces, valued at approximately
$46.7 million. The average amount outstanding under the Gold Consignment
Agreement was $48.0 million for the fiscal year ended January 31, 2004. In the
event this arrangement is terminated, Finlay Jewelry will be required to return
the gold or purchase the outstanding gold at the prevailing gold rate in effect
on that date.
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 January 31, 2004, 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 79 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. Each Department is open for business
during the same hours as its host store.
10
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 group buyer, three 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 five 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 $11,700 in 2003,
$11,700 in 2002 and $12,300 in 2001. Finlay determines average sales per linear
foot by dividing its sales by the aggregate estimated measurements of the outer
perimeters of the display cases of Finlay's Departments. Finlay had average
sales per Department of approximately $932,000, $911,000 and $916,000 in 2003,
2002 and 2001, respectively.
MANAGEMENT INFORMATION AND INVENTORY CONTROL SYSTEMS. Finlay and its
vendors use Finlay's management information systems to monitor sales, gross
margin and inventory performance by location, merchandise category, style number
and vendor. Using this information, Finlay is able to monitor merchandise trends
and variances in performance and improve the efficiency of its inventory
management. Finlay also measures the productivity of its sales force by
maintaining current statistics for each employee such as sales per hour,
transactions per hour and transaction size. In March 2002, Finlay implemented a
new merchandising and inventory control system and a point-of-sale system for
its Departments. These systems have provided improved analysis and reporting
capabilities and will serve to support future growth of Finlay. 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.
As of the end of 2003, Finlay employed approximately 6,200 people 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
6,200 employees, approximately 3,100 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. 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
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 2003, inventory shrinkage amounted to approximately 0.5%
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.
11
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 forward contracts, 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 9% of Finlay Jewelry's cost of goods sold in 2003.
Under such contracts, Finlay 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 January 31, 2004, Finlay
Jewelry had several open positions in gold forward contracts totaling 25,000
fine troy ounces, to purchase gold for $10.2 million, which expire during 2004.
The fair market value of gold under such contracts was $10.0 million at January
31, 2004.
Finlay manages the purchase of forward contracts by estimating and
monitoring the quantity of gold that it anticipates it will require in
connection with its anticipated level of sales of the type described above.
Finlay's gold hedging transactions are entered into by Finlay in the ordinary
course of its business. Finlay's gold hedging strategies are determined and
monitored on a regular basis by Finlay's senior management and its Board of
Directors.
COMPETITION
Finlay faces competition for retail jewelry sales from national and
regional jewelry chains, other department stores, local independently owned
jewelry stores and chains, specialty stores, mass merchandisers, catalog
showrooms, discounters, direct mail suppliers, televised home shopping and the
internet. Management believes that competition in the retail jewelry industry is
based primarily on the price, quality, fashion appeal and perceived value of the
product offered and on the reputation, integrity and service of the retailer.
See "--Store Relationships--Terms of Lease Agreements" with respect to certain
limitations on Finlay's ability to compete.
SEASONALITY
Finlay's business is subject to substantial seasonal variations.
Historically, Finlay has realized a significant portion of its net sales, cash
flow and net income in the fourth quarter of the year principally due to sales
from the holiday season. Finlay expects that this general pattern will continue.
Finlay's results of operations may also fluctuate significantly as a result of a
variety of other factors, including the timing of new store openings and store
closings.
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.
12
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 9,
2004, 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 consolidated financial statements. 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
consolidated financial statements.
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. A number of states in which Finlay
operates have regulations which require retailers who offer merchandise at
discounted prices to offer the merchandise at the "regular" or "original" prices
for stated periods of time. Management believes it is in substantial compliance
with all applicable legal requirements with respect to such practices.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2003.
13
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Finlay Jewelry is a wholly-owned subsidiary of the Holding Company.
Accordingly, there is no established public trading market for Finlay Jewelry's
common stock.
During 2003, cash dividends of $13.5 million were distributed by Finlay
Jewelry to the Holding Company. The distributions are generally utilized to pay
interest on the Holding Company's $75.0 million aggregate principal amount of 9%
Senior Debentures due May 1, 2008 (the "Senior Debentures") and certain expenses
of the Holding Company, such as legal, accounting and directors' fees and to
purchase the Holding Company's common stock, par value $.01 per share ("Common
Stock"), under its stock repurchase program. Certain restrictive covenants in
the indenture relating to Finlay Jewelry's $150.0 million aggregate principal
amount of 83/8% Senior Notes due May 1, 2008 (the "Senior Notes") (the "Senior
Note Indenture") and the indenture relating to 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 Finlay
Jewelry. Additionally, the Revolving Credit Agreement, the Senior Note Indenture
and the Gold Consignment Agreement currently restrict annual distributions from
Finlay Jewelry to the Holding Company to 0.25% of Finlay Jewelry's net sales for
the preceding fiscal year and allow distributions to the Holding 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.
Information regarding the Holding 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.
There was one record holder of Finlay Jewelry's common stock at April 9,
2004.
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. As a result of Federated's decision not to renew Finlay's lease in the
Burdines department store division, the results of operations of Burdines have
been segregated from continuing operations and reported as a discontinued
operation for financial statement purposes for all periods presented. The
statement of operations data and balance sheet data as of and for each of the
years ended January 31, 2004, February 1, 2003, February 2, 2002, February 3,
2001 and January 29, 2000 have been derived from Finlay Jewelry's audited
Consolidated Financial Statements.
FISCAL YEAR ENDED (1)
------------------------------------------------------------------
JAN. 31, FEB. 1, FEB. 2, FEB. 3, JAN. 29,
2004 2003 2002 2001 2000
-------- ------- ------- ------- --------
(DOLLARS IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Sales ............................................ $ 902,416 $ 877,296 $ 900,628 $ 944,756 $ 861,369
Cost of sales .................................. 440,517 424,846 453,246 469,058 424,707
Cost of sales - Sonab inventory write-down (2) - - - - 7,839
--------- --------- --------- --------- ---------
Gross margin (3) ............................... 461,899 452,450 447,382 475,698 428,823
Selling, general and administrative expenses ... 387,501 378,095 374,085 388,601 358,881
(Credit) charges associated with the
sale and closure of Sonab (2) .............. - (1,432) - - 20,792
Depreciation and amortization .................. 17,026 16,827 19,348 16,878 16,312
--------- --------- --------- --------- ---------
Income from operations ......................... 57,372 58,960 53,949 70,219 32,838
Interest expense, net .......................... 16,556 17,678 19,635 22,562 22,043
--------- --------- --------- --------- ---------
Income from continuing operations before
income taxes and cumulative effect of
accounting change .......................... 40,816 41,282 34,314 47,657 10,795
Provision for income taxes ..................... 16,035 16,064 14,369 20,088 5,344
--------- --------- --------- --------- ---------
Income from continuing operations before
cumulative effect of accounting change ..... 24,781 25,218 19,945 27,569 5,451
Discontinued operations, net of tax (4) ........ (11,537) 3,810 3,382 3,860 3,611
Cumulative effect of accounting change,
net of tax (5) ............................. - (17,209) - - -
--------- --------- --------- --------- ---------
Net income ..................................... $ 13,244 $ 11,819 $ 23,327 $ 31,429 $ 9,062
========= ========= ========= ========= =========
OPERATING AND FINANCIAL DATA:
Number of Departments (end of year) ............ 972 1,011 1,006 1,053 987
Percentage increase (decrease) in sales (6) .... 2.9% (2.6)% (4.7)% 9.7% 5.7%
Percentage increase (decrease) in domestic
comparable Department sales (7) ............ 2.3% 0.1% (3.0)% 2.1% 8.1%
Average domestic sales per Department (8) ...... $ 932 $ 911 $ 916 $ 970 $ 929
EBITDA (9) ..................................... 74,398 75,787 73,297 87,097 49,150
Capital expenditures ........................... 12,934 12,489 13,850 18,118 14,972
CASH FLOWS PROVIDED FROM (USED IN):
Operating activities ........................... $ 48,279 $ 52,291 $ 43,658 $ 34,455 $ 46,448
Investing activities ........................... (12,934) (15,750) (17,432) (30,403) (21,054)
Financing activities ........................... (14,349) (17,278) (8,253) (7,640) (7,159)
BALANCE SHEET DATA-END OF PERIOD:
Working capital ................................ $ 196,496 $ 173,960 $ 173,334 $ 152,003 $ 132,696
Total assets ................................... 592,324 578,575 583,422 602,254 554,994
Short-term debt, including current portion of
long-term debt .............................. - - - - -
Long-term debt ................................. 150,000 150,000 150,000 150,000 150,000
Total stockholder's equity ..................... 185,100 187,816 193,596 179,423 157,026
15
- -----------------
(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,
Finlay Jewelry's European leased jewelry department subsidiary, 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 Finlay Jewelry's estimate of closure expenses to reflect its
remaining liability associated with the closure of Sonab. Refer to Note 15
of Notes to Consolidated Financial Statements for additional information
regarding Sonab.
(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: $4.5
million, $2.2 million, $3.6 million, $1.7 million, and $(1.1) million for
2003, 2002, 2001, 2000 and 1999, respectively.
(4) In accordance with Statement of Financial Accounting Standards ("SFAS") No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets", the
results of operations of the Burdines Departments have been segregated from
continuing operations and reflected as a discontinued operation for
financial statement purposes for all periods presented. Refer to Note 11 of
Notes to Consolidated Financial Statements for additional information
regarding discontinued operations.
(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"), Finlay Jewelry 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
of $11.7 million. The application of EITF 02-16 changed Finlay Jewelry's
accounting treatment for the recognition of vendor allowances. In 2003 and
2002, $19.4 million and $18.9 million, respectively, of vendor allowances
has been reflected as a reduction to cost of sales. In prior years, these
allowances were 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 for additional
information regarding EITF 02-16.
(6) 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%.
(7) Comparable Department sales are calculated by comparing the sales from
Departments open for the same months in the comparable periods.
(8) 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.
(9) EBITDA, a non-GAAP financial measure, represents income from operations
before depreciation and amortization expenses, and excludes discontinued
operations. Finlay 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 determined in accordance
with GAAP) for the purpose of analyzing Finlay's operating performance,
financial position and cash flow 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.
EBITDA is calculated as follows:
FISCAL YEAR ENDED
--------------------------------------------------------------------
JAN. 31, FEB. 1, FEB. 2, FEB. 3, JAN. 29,
2004 2003 2002 2001 2000
-------- ------- ------- ------- --------
(DOLLARS IN THOUSANDS)
Income from operations .................. $57,372 $58,960 $53,949 $70,219 $32,838
Add: Depreciation and amortization ...... 17,026 16,827 19,348 16,878 16,312
------- ------- ------- ------- -------
EBITDA .................................. $74,398 $75,787 $73,297 $87,097 $49,150
======= ======= ======= ======= =======
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.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations ("MD&A") is provided as a supplement to the
accompanying consolidated financial statements and notes thereto contained in
Item 8 of this report. This MD&A is organized as follows:
o EXECUTIVE OVERVIEW - This section provides a general description of
Finlay's business and a brief discussion of the opportunities,
challenges and risks that Finlay focuses on in the operation of its
business.
o RESULTS OF OPERATIONS - This section provides an analysis of the
significant line items on the consolidated statements of operations.
o LIQUIDITY AND CAPITAL RESOURCES - This section provides an analysis of
liquidity, cash flows, sources and uses of cash, contractual
obligations and financial position.
o SEASONALITY - This section describes the effects of seasonality on
Finlay's business.
o CRITICAL ACCOUNTING POLICIES AND ESTIMATES - This section discusses
those accounting policies that both are considered important to Finlay
Jewelry's financial condition and results of operations, and require
Finlay Jewelry to exercise subjective or complex judgments in their
application. In addition, all of Finlay Jewelry's significant
accounting policies, including critical accounting policies, are
summarized in Note 2 to the consolidated financial statements.
o SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS - This section
provides cautionary information about forward-looking statements and a
description of certain risks and uncertainties that could cause actual
results to differ materially from Finlay Jewelry's historical results
or current expectations or projections.
The Burdines Departments have been accounted for as a discontinued
operation, and, unless otherwise indicated, the following discussion relates to
Finlay Jewelry's continuing operations.
EXECUTIVE OVERVIEW
OUR BUSINESS
Finlay is one of the leading retailers of fine jewelry in the United States
and operates leased fine jewelry Departments in major department stores for
retailers such as May and Federated. Finlay sells a broad selection of
moderately priced jewelry, with an average sales price of approximately $191 per
item. As of January 31, 2004, Finlay operated 972 locations in 17 host store
groups, in 46 states and the District of Columbia.
Finlay's primary focus is to offer desirable and competitively priced
products and to provide superior merchandise assortments, quality and customer
service. Finlay's ability to quickly identify emerging trends and maintain
strong relationships with vendors has enabled Finlay to present better
assortments in its showcases. Finlay believes that it is an important
contributor to each of its host store groups and continues to seek opportunities
to penetrate the department store segment. By outsourcing their fine jewelry
departments to Finlay, host store groups gain Finlay's expertise in
merchandising, selling and marketing jewelry and customer service. Additionally,
by avoiding high working capital investments typically required of the
traditional retail jewelry business, host stores improve their return on
investment and increase their profitability. As a lessee, Finlay benefits from
the host stores' reputation, customer traffic, credit services and established
customer base. Finlay also avoids the substantial capital investment
17
in fixed assets typical of a stand-alone retail format. These factors have
generally led Finlay's new Departments to achieve profitability within the first
twelve months of operation.
Finlay Jewelry measures itself against key financial measures that it
believes provide a well-balanced perspective regarding its overall financial
success. Those benchmarks are as follows, together with how they are computed:
o Comparable department sales growth computed as the percentage change in
sales for Departments open for the same months during the comparable
periods. Comparable department sales are measured against Finlay's host
store groups as well as other jewelry retailers;
o Total net sales growth (current year total net sales minus prior year total
net sales divided by prior year total net sales equals percentage change)
which indicates, among other things, the success of Finlay's selection of
new store locations and the effectiveness of its merchandising strategies.
o Operating margin rate (income from operations divided by net sales) which
is an indicator of Finlay Jewelry's success in leveraging its fixed costs
and managing its variable costs; and
2003 HIGHLIGHTS
During 2003, Finlay successfully executed its marketing and merchandising
strategy, as evidenced by its 2.3% growth in comparable department sales
(including Burdines), achieved strong operating cash flow and increased
profitability. Over the past decade, Finlay has experienced comparable store
sales increases (in nine out of ten years) and has consistently outperformed its
host store groups with respect to these increases. Finlay attributes its success
to an experienced and stable management team, a well-trained and highly
motivated sales force, an expert jewelry merchandising team, unique vendor
relationships and an established customer base. Total sales were $902.4 million
in 2003 compared to $877.3 million in 2002, an increase of 2.9%. Gross margin
increased by $9.4 million in 2003 compared to 2002, and as a percentage of
sales, gross margin decreased by 0.4% from 51.6% to 51.2%. Although SG&A
increased $9.4 million, as a percentage of sales, SG&A decreased 0.2% from 43.1%
to 42.9%.
During 2003, Finlay Jewelry effectively managed its inventories and
implemented appropriate expense controls. Finlay Jewelry's continued focus on
cash management enabled Finlay Jewelry to end 2003 with $89.5 million of cash
compared to $68.5 million at the end of 2002. Finlay Jewelry's operating cash
flow was $48.3 million in 2003, which enabled Finlay Jewelry to open new
Departments and remodel and expand existing Departments. Additionally,
borrowings under the Revolving Credit Agreement were reduced to zero by the end
of December 2003 and the average outstanding balance decreased by 30% to $42.7
million as compared to $61.2 million in the prior year. Maximum outstanding
borrowings during 2003 peaked at $93.5 million, at which point the available
borrowings under the Revolving Credit Agreement were approximately $122.5
million.
18
OUTLOOK
Finlay continues to seek growth opportunities and plans to continue to
pursue the following key initiatives to further increase sales and earnings:
o Increase comparable department sales;
o Add Departments within existing host store groups;
o Add new host store relationships;
o Open new channels of distribution;
o Continue to raise customer service standards;
o Strengthen selling teams through training programs;
o Continue to improve operating leverage; and
o De-leverage the balance sheet.
See "Business-Growth Strategy" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
Management believes that current trends in jewelry retailing provide a
significant opportunity for Finlay's growth. Consumers spent approximately $54.0
billion on jewelry (including both fine jewelry and costume jewelry) in the
United States in 2003, an increase of approximately $19.9 billion over 1993,
according to the United States Department of Commerce. In the department store
sector in which Finlay operates, consumers spent an estimated $4.1 billion on
fine jewelry in 2002. Management believes that demographic factors such as the
aging of the baby boomer generation with increased discretionary income, plus
the growing number of women in the workplace, will contribute to the growth of
the fine jewelry retailing industry.
OPPORTUNITIES, RISKS AND UNCERTAINTIES
Finlay achieved sustained growth during 2003, however, Finlay has faced
certain challenges as well, including:
o Dependence on or loss of certain host store relationships; and
o Host store consolidation.
During 2003, Federated announced that it would not renew Finlay's lease in
the Burdines department store division, which resulted in the closure of 46
Burdines Departments in January 2004. These 46 Departments generated
approximately $55 million in revenue during 2003, which is included in
discontinued operations. Due to the termination of the Burdines lease, Finlay
recorded a non-cash charge of $13.8 million for the write-down of goodwill
resulting from the closure of the Burdines Departments.
Additionally, during 2003, May announced its intention to close certain of
its smaller, less profitable stores, including 32 Lord & Taylor stores, as well
as two stores in its Famous-Barr division, resulting in the closure of eight
Departments in 2003 and six Departments during the first quarter of 2004. In
2003, Finlay generated approximately $20 million in sales from these 34
Departments.
19
During 2003, approximately 51% and 18% of Finlay's sales were generated by
Departments operated in store groups owned by May and Federated, respectively.
Finlay has operated Departments with May since 1948 and with Federated since
1983. Finlay believes that its relationships with these hosts are excellent.
Nevertheless, a decision by either company to transfer the operation of some or
all of their Departments to a competitor or to assume the operation of those
Departments themselves would have a material adverse effect on the business and
financial condition of Finlay. Additionally, the department store industry may
experience significant consolidations in the future. Although Finlay has, in the
past, generally benefited from host store consolidations, there is no assurance
that Finlay's host store relationships will not be impacted as a result of such
host store consolidation.
An important initiative and focus of management is developing opportunities
for the growth of Finlay. Management considers it a high priority to identify
new businesses that offer growth, financial viability and manageability and will
have a positive impact on shareholder value.
Finlay is currently evaluating the potential refinancing of the Senior
Debentures and the Senior Notes. The Senior Debentures and Senior Notes were
originally issued in May 1998 and mature on May 1, 2008. In addition, they
became redeemable, at the option of Finlay, on May 1, 2003.
RESULTS OF OPERATIONS
The following table sets forth operating results as a percentage of sales
for the periods indicated. The discussion that follows should be read in
conjunction with the following table:
FISCAL YEAR ENDED
-------------------------------------
JAN. 31, FEB. 1, FEB. 2,
2004 2003 2002
-------- ------- -------
STATEMENT OF OPERATIONS DATA:
Sales.................................................... 100.0% 100.0% 100.0%
Cost of sales............................................ 48.8 48.4 50.3
----- ----- -----
Gross margin........................................... 51.2 51.6 49.7
Selling, general and administrative expenses............. 42.9 43.1 41.5
Credit associated with the sale and
closure of Sonab...................................... - (0.1) -
Depreciation and amortization............................ 1.9 1.9 2.2
----- ----- -----
Income from operations................................... 6.4 6.7 6.0
Interest expense, net.................................... 1.9 2.0 2.2
----- ----- -----
Income from continuing operations before income
taxes and cumulative effect of accounting change..... 4.5 4.7 3.8
Provision for income taxes............................... 1.8 1.8 1.6
----- ----- -----
Income from continuing operations before
cumulative effect of accounting change............... 2.7 2.9 2.2
Discontinued operations, net of tax (1).................. (1.3) 0.4 0.4
Cumulative effect of accounting change,
net of tax (2) ...................................... - (1.9) -
----- ----- -----
Net income.............................................. 1.4% 1.4% 2.6%
===== ===== =====
- ----------------
(1) See Note 4 to "Selected Consolidated Financial Data".
(2) See Note 5 to "Selected Consolidated Financial Data".
20
2003 COMPARED WITH 2002
SALES. Sales increased $25.1 million, or 2.9%, in 2003 compared to 2002.
The increase in sales is due primarily to the 2.3%, or $18.7 million, increase
in comparable department sales. Additionally, total sales increased by $6.4
million as a result of the net effect and timing of new Department openings and
closings. Management attributes the increase in sales primarily to Finlay's
merchandising and marketing strategy, which includes the following initiatives:
(i) emphasizing its "Best Value" merchandising programs, which provide a
targeted assortment of items at competitive prices; (ii) focusing on holiday and
event-driven promotions as well as host store marketing programs; and (iii)
positioning Finlay's Departments as a "destination location" for fine jewelry.
Finlay's major merchandise categories include diamonds, gold, gemstones and
watches. Diamond sales increased $24.3 million, or 9.7%, in 2003 compared to
2002 due primarily to the increase in consumer demand for diamond fashion
assortments, including emerging merchandise categories such as three-stone
jewelry. Sales in all other categories remained relatively flat in 2003 compared
to 2002.
During 2003, Finlay opened 32 Departments, within existing store groups,
and closed 71 Departments. The openings were comprised of the following:
NUMBER OF
STORE GROUP DEPARTMENTS
----------- -----------
May........................ 10
Dillard's.................. 9
Federated.................. 5
Saks....................... 3
Other...................... 5
--
Total............. 32
==
The closings were comprised of the following:
NUMBER OF
STORE GROUP DEPARTMENTS REASON
- --------------------------- ----------- -------------------------------------------------
Burdines................... 46 Federated did not renew Finlay's lease.
Lord & Taylor.............. 7 May closed these less profitable locations.
Other...................... 18 Department closings within existing store groups.
--
Total............ 71
==
GROSS MARGIN. Gross margin increased by $9.4 million in 2003 compared to
2002, and as percentage of sales, gross margin decreased by 0.4%. The components
of this 0.4% net decrease in gross margin are as follows:
COMPONENT % REASON
- ---------------------------- ----- -------------------------------------------------
Merchandise cost of sales.. (0.6%) Increase in merchandise cost of sales is due to
management's continued efforts to increase market
penetration and market share through its pricing
strategy and the impact of higher gold prices.
LIFO ...................... (0.2%) Increase in LIFO provision from $2.2 million to
$4.5 million.
Shortage .................. 0.4% Decrease in shortage is due primarily to
---- favorable physical inventory results.
Total ............... (0.4%)
====
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The components of SG&A
include payroll expense, lease fees, net advertising expenditures and other
field and administrative expenses. SG&A increased $9.4 million, or 2.5%. As a
percentage of sales, SG&A decreased to 42.9% from 43.1%. The components of this
0.2% net decrease in SG&A are as follows:
21
COMPONENT % REASON
- ---------------------------------- --- -------------------------------------------------
Net advertising expenditures...... 0.2% Decrease in net advertising expenditures is due
primarily to increased vendor support.
Payroll expense .................. (0.1%) Favorably impacted by the leveraging of payroll
expense, offset by an increase in medical
expenses as 2002 included a $1.8 million
benefit. This $1.8 million benefit related to
favorable claims experience following a change
in medical insurance carriers.
Other field expenses.............. 0.1% Decrease in other field expenses is due
--- primarily to the favorable leveraging of these
expenses.
Total ............. 0.2%
===
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased $0.2
million reflecting additional depreciation and amortization as a result of
capital expenditures for the most recent twelve months, offset by the effect of
certain assets becoming fully depreciated. In addition, accelerated depreciation
costs totaling approximately $0.4 million, associated with the Lord & Taylor
store closings, were recorded in the period.
INTEREST EXPENSE, NET. Interest expense decreased by $1.1 million primarily
due to a decrease in average borrowings ($192.7 million for 2003 compared to
$211.2 million for 2002). The weighted average interest rate was approximately
7.3% for 2003 compared to 7.1% for 2002.
PROVISION FOR INCOME TAXES. The income tax provision for 2003 and 2002
reflects effective tax rates of 39.3% and 38.9%, respectively. The income tax
provision in 2002 was reduced for certain income tax accruals which were no
longer required.
DISCONTINUED OPERATIONS. Discontinued operations includes the results of
operations of the Burdines department store division. The net loss from
discontinued operations for 2003 was $11.5 million compared to the net income
from discontinued operations of $3.8 million in 2002. The loss in 2003 included
$1.2 million of pre-tax charges associated with the accelerated depreciation of
fixed assets and severance, as well as a charge of $13.8 million for the
write-down of goodwill resulting from the Burdines Department closings.
NET INCOME. Net income of $13.2 million for 2003 represents an increase of
$1.4 million as compared to net income of $11.8 million in 2002 as a result of
the factors discussed above.
2002 COMPARED WITH 2001
SALES. Sales decreased $23.3 million, or 2.6%, in 2002 compared to 2001.
Comparable Department sales increased 0.1% in 2002, which management attributes
to a continued challenging retail environment. Total sales were negatively
impacted by approximately $31.0 million, or 3.4%, 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
emphasizing its "Best Value" merchandising programs as discussed above.
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 $5.1 million in 2002 compared to
2001 and, as a percentage of sales, gross margin increased by 1.9%, primarily
due to Finlay Jewelry's adoption of EITF 02-16. The application of EITF 02-16
changed Finlay Jewelry's accounting treatment for the recognition
22
of vendor allowances. In 2002, $18.9 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.
Excluding the adoption of EITF 02-16, gross margin decreased by $13.8
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 $2.2 million in
2002 versus $3.6 million in 2001.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A totaled $378.1 million,
an increase of $4.0 million, or 1.1%, in 2002 compared to 2001, primarily due to
Finlay Jewelry's adoption of EITF 02-16 which, as discussed above, resulted in a
$18.9 million increase to SG&A. SG&A as a percentage of sales increased to 43.1%
in 2002 from 41.5% in 2001.
Excluding the adoption of EITF 02-16, SG&A decreased by $14.9 million, or
4.0%, in 2002 compared to 2001 primarily due to payroll expense and lease fees
associated with the decrease in Finlay Jewelry's sales and reduced gross
advertising expenses. Additionally, Finlay Jewelry 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 40.9% in
2002 from 41.5% in 2001.
CREDIT ASSOCIATED WITH THE SALE AND CLOSURE OF SONAB. In 2002, Finlay
Jewelry 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 twelve
months.
INTEREST EXPENSE, NET. Interest expense decreased by $2.0 million
reflecting a lower weighted average interest rate (7.1% for 2002 compared to
7.4% for 2001) and a decrease in average borrowings ($211.2 million for 2002
compared to $230.8 million for 2001).
PROVISION FOR INCOME TAXES. The effective tax rate, before the cumulative
effect of accounting change, decreased to 38.9% in 2002 from 41.7% in 2001,
primarily as a result of the cessation in 2002 of the amortization of
non-deductible goodwill.
DISCONTINUED OPERATIONS. The net income from discontinued operations
increased $0.4 million from $3.4 million in 2001 to $3.8 million in 2002.
Discontinued operations includes the results of operations of the Burdines
department store division, which has been segregated from continuing operations
for financial statement purposes.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET OF TAXES. Finlay Jewelry
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 Finlay Jewelry's previously collected
vendor allowances relating to both owned merchandise and merchandise received on
consignment.
NET INCOME. Net income of $11.8 million for 2002 represents a decrease of
$11.5 million as compared to net income of $23.3 million in 2001 as a result of
the factors discussed above.
23
LIQUIDITY AND CAPITAL RESOURCES
Information about Finlay Jewelry's financial position as of January 31,
2004 and February 1, 2003 is presented in the following table:
JANUARY 31, FEBRUARY 1,
2004 2003
---- ----
(IN THOUSANDS)
Cash and cash equivalents......... $ 89,481 $ 68,485
Working capital................... 196,496 173,960
Long-term debt.................... 150,000 150,000
Stockholder's equity.............. 185,100 187,816
Finlay's primary capital requirements are for funding working capital for
new Departments and for working capital growth of existing Departments, as well
as debt service obligations and lease payments to host store groups, and, to a
lesser extent, capital expenditures for opening new Departments, renovating
existing Departments and information technology investments. For 2003 and 2002,
capital expenditures totaled $12.9 million and $12.5 million, respectively.
Total capital expenditures for 2004 are estimated to be approximately $12.0
million. Although capital expenditures are limited by the terms of the Revolving
Credit Agreement, to date, this limitation has not precluded Finlay from
satisfying its capital expenditure requirements.
Finlay currently expects to fund capital expenditure requirements as well
as liquidity needs from a combination of cash, internally generated funds and
financing arrangements. Finlay believes that its internally generated liquidity
through cash flow from operations, together with access to external capital
resources, will be sufficient to satisfy existing commitments and plans and will
provide adequate financing flexibility.
Cash flows for the fiscal years ended January 31, 2004, February 1, 2003
and February 2, 2002 were as follows:
FISCAL YEARS ENDED
-------------------------------------------------
(IN THOUSANDS) JANUARY 31, FEBRUARY 1, FEBRUARY 2,
2004 2003 2002
----------- ----------- -----------
Operating Activities........................ $48,279 $52,291 $43,658
Investing Activities........................ (12,934) (15,750) (17,432)
Financing Activities........................ (14,349) (17,278) (8,253)
------- ------- ------
Total Cash Provided from Operations.. $20,996 $19,263 $17,973
======= ======= ======
Finlay's current priorities for its use of cash or borrowings, as a result
of borrowings available under the Revolving Credit Agreement, are:
o Capital expenditures for new Departments, expansions and remodeling of
existing Departments;
o Investments in technology; and
o Strategic acquisitions.
OPERATING ACTIVITIES
The primary source of Finlay's liquidity is cash flows from operating
activities. The key component of operating cash flow is merchandise sales.
Operating cash outflows include payments to vendors for inventory, services and
supplies, payments for employee payroll, lease payments and payments of interest
and taxes. Net cash flows from operations were $48.3 million for 2003, a
decrease from 2002 levels due primarily to a $9.4 million, or 3.6%, increase in
inventory offset by an increase in accounts payable in the current year. The
increase in inventory was in line with Finlay's increase in sales.
24
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, approximately 50% of Finlay's merchandise has been
carried on consignment. Finlay Jewelry's working capital balance was $196.5
million at January 31, 2004, an increase of $22.5 million from February 1, 2003.
The increase resulted primarily from the impact of 2003's net income (exclusive
of depreciation and amortization and the goodwill write-down related to
Burdines) partially offset by capital expenditures and the payment of dividends
to the Holding Company.
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 that month.
These proceeds result in a significant increase in Finlay's cash, which is used
to reduce Finlay's borrowings under the Revolving Credit Agreement.
INVESTING ACTIVITIES
Investment cash outflows include payments for capital expenditures,
including property and equipment. Net cash used in investing activities was
$12.9 million, $15.8 million and $17.4 million in 2003, 2002 and 2001,
respectively. Capital expenditures in 2003 and 2002 related primarily to
expenditures for new Department openings and renovations.
FINANCING ACTIVITIES
Payments on debt and dividends to the Holding Company have been Finlay
Jewelry's primary financing activities. Net cash used in financing activities
was $14.3 million, $17.3 million and $8.3 million in 2003, 2002 and 2001,
respectively, consisting principally of the payment of dividends to the Holding
Company.
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) the adjusted Eurodollar rate plus a margin ranging from 1.0% to
2.0%, in each case depending on the financial performance of Finlay. The
weighted average interest rate was 3.4% and 3.9% for 2003 and 2002,
respectively.
In each year, Finlay is required to reduce the outstanding revolving credit
balance and letter of credit balance under the Revolving Credit Agreement to
$50.0 million or less and $20.0 million or less, respectively, for a 30
consecutive day period (the "Balance Reduction Requirement"). Borrowings under
the Revolving Credit Agreement at January 31, 2004 and February 1, 2003 were
zero. The average amounts outstanding under the Revolving Credit Agreement
during 2003 and 2002 were $42.7 million and $61.2 million, respectively. The
maximum amount outstanding during 2003 was $93.5 million, at which point the
available borrowings were $122.5 million.
25
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 January 31, 2004, Finlay Jewelry's outstanding borrowings
included a $150.0 million balance under the Senior Notes.
Finlay Jewelry's agreements covering the Revolving Credit Agreement 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 January 31, 2004, Finlay Jewelry was in compliance with all of its
covenants. Management expects to be in compliance with all of its covenants
through 2004. Because compliance is based, in part, on management estimates and
actual results can differ from those estimates, there can be no assurance that
Finlay Jewelry will be in compliance with the covenants in the future or that
the lenders will waive or amend any of the covenants should Finlay Jewelry be in
violation thereof. Finlay Jewelry 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 Credit Agreement also contains various financial covenants, including
minimum earnings and fixed charge coverage ratio requirements and certain
maximum debt limitations.
The Senior Note Indenture contains 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.
Finlay 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 became
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 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. Finlay is currently
evaluating the potential refinancing of the Senior Debentures and the Senior
Notes.
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
Holding Company sufficient to permit the Holding Company to meet its debt
service obligations and to pay certain other expenses as they come due. No
assurances, however, can be given that Finlay Jewelry's current level of
operating results will continue or improve or that Finlay Jewelry's income from
operations will continue to be sufficient to permit Finlay Jewelry and the
Holding Company to meet their debt service and other obligations. Currently,
Finlay Jewelry's principal financing arrangements restrict annual distributions
from Finlay Jewelry to the Holding Company to 0.25% of Finlay Jewelry's net
sales for the preceding fiscal year and also allow distributions to the Holding
Company to enable it to make interest payments on the Senior Debentures. 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 $16.0 million and $16.8 million in 2003 and 2002,
respectively.
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 January 31, 2004 and February 1,
2003, $364.5 million and $359.7 million, respectively, of consignment
merchandise from
26
approximately 300 vendors was on hand. For 2003, Finlay had an average balance
of consignment merchandise of $364.7 million as compared to an average balance
of $360.5 million in 2002.
The following tables summarize Finlay Jewelry's contractual and commercial
obligations which may have an impact on future liquidity and the availability of
capital resources, as of January 31, 2004 (dollars in thousands):
PAYMENTS DUE BY PERIOD
----------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1 YEAR 1 - 3 YEARS 3 - 5 YEARS MORE THAN 5 YEARS
----------------------- ----- ---------------- ----------- ----------- -----------------
Long-Term Debt Obligations:
Senior Notes (due 2008)(1) .... $150,000 $ - $ - $150,000 $ -
Operating lease obligations (2) . 9,070 2,028 3,847 3,195 -
-------- -------- -------- -------- ----------
Total ........................... $159,070 $ 2,028 $ 3,847 $153,195 $ -
======== ======== ======== ======== ==========
- -----------
(1) The Holding Company has $75.0 million of Senior Debentures due 2008
outstanding. Refer to Note 5 of Notes to the Consolidated Financial
Statements.
(2) 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 3 - 5 YEARS MORE THAN 5 YEARS
----------- ----- ---------------- ----------- ----------- -----------------
Revolving Credit
Agreement (due 2008) (1) ......... $ - $ - $ - $ $ -
Gold Consignment
Agreement (expires 2005) (2) ...... 46,700 46,700 - - -
Letters of credit 8,950 8,700 - - 250
------- ------- -------- ------- ----------
Total ................................ $55,650 $55,400 $ - $ - $ 250
======= ======= ======== ======= ==========
- ------------
(1) There were no borrowings under the Revolving Credit Agreement at January
31, 2004. The average amount outstanding during 2003 was $42.7 million and
the outstanding balance as of April 9, 2004 was $19.0 million.
(2) Represents amount outstanding at January 31, 2004.
Finlay enters into arrangements with vendors to purchase merchandise up to
three months in advance of expected delivery. These purchase orders do not
contain any significant termination payments or other penalties if cancelled.
OFF-BALANCE SHEET ARRANGEMENTS
Finlay Jewelry's Gold Consignment Agreement 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. The Gold Consignment Agreement matures on July 31, 2005 and permits
Finlay Jewelry to consign 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. Finlay Jewelry believes its relationship with the gold
consignor is good and expects to be in a position to extend the Gold Consignment
Agreement upon its expiration. At January 31, 2004, amounts outstanding under
the Gold Consignment Agreement totaled 116,835 fine troy ounces, valued at
approximately $46.7 million. The average amount outstanding under the Gold
Consignment Agreement was $48.0 million in 2003. In the event this agreement is
terminated, Finlay Jewelry will be required to return the gold or purchase the
outstanding gold at the prevailing gold rate in effect on that date. For
financial statement purposes, the consigned gold is not
27
included in merchandise inventories on Finlay Jewelry's Consolidated Balance
Sheets and, therefore, no related liability has been recorded.
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. At January 31, 2004, Finlay Jewelry was in compliance with all of
its covenants under the Gold Consignment Agreement.
Finlay Jewelry has not created, and is not party to, any off-balance sheet
entities for the purpose of raising capital, incurring debt or operating Finlay
Jewelry's business. Finlay Jewelry does not have any arrangements or
relationships with entities that are not consolidated into the financial
statements that are reasonably likely to materially affect Finlay Jewelry's
liquidity or the availability of capital resources.
OTHER ACTIVITIES AFFECTING LIQUIDITY
Finlay 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. This agreement has a remaining term of approximately
one year and has a remaining aggregate minimum value of $1.0 million as of
January 31, 2004.
From time to time, Finlay enters into forward contracts based upon the
anticipated sales of gold product in order to hedge against the risk arising
from its payment arrangements. At January 31, 2004, Finlay Jewelry had several
open positions in gold forward contracts totaling 25,000 fine troy ounces, to
purchase gold for $10.2 million. There can be no assurance that these hedging
techniques will be successful or that hedging transactions will not adversely
affect Finlay Jewelry's results of operations or financial position.
In January 2000, Sonab, Finlay Jewelry's European leased jewelry department
subsidiary, sold the majority of its assets for approximately $9.9 million.
Finlay Jewelry recorded a pre-tax charge in the fourth quarter of 1999 of $28.6
million. As of January 31, 2004, Finlay Jewelry's exit plan has been completed
with the exception of certain employee litigation and other legal matters.
During the fourth quarter of 2002, Finlay Jewelry revised its original estimate
of closure expenses to reflect its remaining liability and, as a result, reduced
its accrual by $1.4 million. To date, Finlay Jewelry has charged a total of
$26.4 million against its revised estimate of $27.2 million. Finlay Jewelry does
not believe future operating results or liquidity will be materially impacted by
any remaining payments or litigation and legal matters mentioned above.
SEASONALITY
Finlay's business is highly seasonal, with a significant portion of its
sales and income from operations generated during the fourth quarter of each
year, which includes the year-end holiday season. The fourth quarter accounted
for an average of approximately 42% of Finlay's sales and approximately 86% of
its income from operations for 2003 and 2002. Finlay has typically experienced
net losses in the first three quarters of its fiscal year. During these periods,
working capital requirements have been funded by borrowings under the Revolving
Credit Agreement. Accordingly, the results for any of the first three quarters
of any given fiscal year, taken individually or in the aggregate, are not
indicative of annual results. See Note 13 of Notes to Consolidated Financial
Statements of Finlay Jewelry.
28
The following table summarizes the quarterly financial data for 2003 and
2002:
FISCAL QUARTER
-------------------------------------------------------------
FIRST SECOND THIRD FOURTH
----- ------ ----- ------
(DOLLARS IN THOUSANDS)
(UNAUDITED)
2003:
Sales ........................... $ 175,427 $ 182,229 $ 165,784 $ 378,976
Gross margin .................... 90,766 92,796 84,717 193,620
Income (loss) from operations ... 2,669 4,502 (62) 50,263
Net income (loss) ............... (234) 645 (2,713) 15,546 (a)
2002:
Sales ........................... 176,354 176,284 159,515 365,143
Gross margin .................... 92,333 90,332 83,187 186,598
Income (loss) from operations ... 4,661 3,979 50 50,270
Net income (loss) ............... (16,019) (b) 447 (2,173) 29,564
- -----------------
(a) Net income (loss) includes the write-down of goodwill of $13.8 million in
the fourth quarter of 2003.
(b) In accordance with EITF 02-16, Finlay Jewelry recorded a cumulative effect
of accounting change as of February 3, 2002, the date of adoption, that
decreased net income by $17.2 million, net of tax of $11.7 million.
INFLATION
The effect of inflation on Finlay's results of operations has not been
material in the periods discussed.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Finlay Jewelry'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 Finlay Jewelry's significant accounting policies are described
in Note 2 of Notes to the Consolidated Financial Statements. Finlay believes
that the following discussion addresses the critical accounting policies, which
are most important to the portrayal of Finlay Jewelry's financial condition and
results of operations and require management's most difficult, subjective or
complex judgments. Finlay Jewelry 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
Finlay Jewelry 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 Finlay Jewelry's reported operating
results.
29
Shrinkage is estimated for the period from the last inventory date to the
end of the fiscal year on a store by store basis. The shrinkage rate from the
most recent physical inventory, in combination with historical experience, is
the basis for estimating shrink.
DERIVATIVE INSTRUMENTS
Finlay is exposed to market risk related to changes in the price of gold
and at times enters into forward contracts, to hedge against the risk of gold
price fluctuations. When specific criteria as required by SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," have been met,
changes in the fair value of forward contracts are recorded in other
comprehensive income and reclassified into cost of sales when the offsetting
effects of the hedged transaction impact earnings. One of the criteria for this
accounting treatment is that the forward contract amount may not be in excess of
specifically identified anticipated transactions. Changes in the fair value of
the derivative attributable to hedge ineffectiveness are reclassified from other
comprehensive income to other income/expense during the period in which such
changes occur.
VENDOR ALLOWANCES
Finlay Jewelry receives allowances from its vendors through a variety of
programs and arrangements, including cooperative advertising. Vendor allowances
are recognized as a reduction of cost of sales upon the sale of merchandise or
SG&A when the purpose for which the vendor funds were 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.
Effective in 2002, Finlay Jewelry adopted EITF 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.
FINITE-LIVED ASSETS
Finite-lived assets are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of the assets may not be
recoverable. If the undiscounted future cash flows from the finite-lived assets
are less than the carrying value, Finlay Jewelry recognizes a loss equal to the
difference between the carrying value and the fair value of the asset. Finlay
Jewelry determines the fair value of the underlying asset based upon the
discounted future cash flows of the assets. Various factors, including future
sales growth and profit margins, are included in this analysis. To the extent
these future projections or Finlay Jewelry's strategies change, the conclusion
regarding impairment may differ from the current estimates.
GOODWILL
Finlay Jewelry evaluates goodwill for impairment annually or whenever
events and changes in circumstances suggest that the carrying amount may not be
recoverable from its estimated future cash flows. To the extent these future
cash flows or Finlay Jewelry's strategies change, the conclusion regarding
impairment may differ from current estimates.
30
REVENUE RECOGNITION
Finlay Jewelry 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 Finlay Jewelry's historical return rate.
SELF-INSURANCE RESERVES
Finlay Jewelry is self-insured for workers' compensation claims up to a
certain maximum liability amount. Although the amount accrued is actuarially
determined based on analysis of historical trends of losses, settlements,
litigation costs and other factors, the amount that Finlay Jewelry will
ultimately disburse could differ materially from the accrued amount.
INCOME TAXES
Finlay Jewelry is subject to income taxes in many jurisdictions and must
first determine which revenues and expenses should be included in each taxing
jurisdiction. This process involves the estimation of Finlay Jewelry's actual
current tax exposure, together with the assessment of temporary differences
resulting from differing treatment of income or expense items for tax and
accounting purposes. Finlay Jewelry establishes tax reserves in its consolidated
financial statements based on its estimation of current tax exposures. If Finlay
Jewelry prevails in tax matters for which reserves have been established or
Finlay Jewelry is required to settle matters in excess of established reserves,
the effective tax rate for a particular period could be materially affected.