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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: 0-25716
FINLAY ENTERPRISES, INC.
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(Exact name of registrant as specified in its charter)
Delaware 13-3492802
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
529 Fifth Avenue New York, NY 10017
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(Address of principal executive offices) (zip code)
212-808-2800
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
---------------------------------
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 [X] No [ ]
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant on August 3, 2003 was $126,122,847, based on
the closing price on the Nasdaq National Market for the common stock on such
date. The registrant does not have any nonvoting common equities.
As of April 9, 2004, there were 10,826,871 shares of common stock, par value
$.01 per share, of the registrant outstanding.
Documents incorporated by reference:
Portions of the Company's definitive Proxy Statement, in connection with its
Annual Meeting to be held in June 2004, are incorporated by reference into Part
III. The Company's Proxy Statement will be filed within 120 days after January
31, 2004.
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FINLAY ENTERPRISES, INC
FORM 10-K
FOR THE FISCAL YEAR ENDED JANUARY 31, 2004
INDEX
PAGE(S)
-------
PART I
Item 1. Business............................................................................. 3
Item 2. Properties...........................................................................13
Item 3. Legal Proceedings....................................................................13
Item 4. Submission of Matters to a Vote of Security Holders..................................13
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters...........................................................................14
Item 6. Selected Consolidated Financial Data.................................................16
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations...............................................20
Item 7A. Quantitative and Qualitative Disclosures about Market Risk...........................36
Item 8. Financial Statements and Supplementary Data..........................................37
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...............................................37
Item 9A. Controls and Procedures..............................................................37
PART III
Item 10. Directors and Executive Officers of the Registrant...................................39
Item 11. Executive Compensation...............................................................42
Item 12. Security Ownership of Certain Beneficial Owners and Management.......................42
Item 13. Certain Relationships and Related Transactions.......................................45
Item 14. Principal Accountant Fees and Services...............................................46
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.....................46
SIGNATURES ....................................................................................53
2
PART I
ITEM 1. BUSINESS
THE COMPANY
Finlay Enterprises, Inc., a Delaware corporation (the "Company"), conducts
business through its wholly-owned subsidiary, Finlay Fine Jewelry Corporation, a
Delaware corporation, and its wholly-owned subsidiaries ("Finlay Jewelry").
References to "Finlay" mean, collectively, the Company and Finlay Jewelry. All
references herein to "Departments" refer to fine jewelry departments operated
pursuant to license agreements or other arrangements with host department
stores.
Finlay is one of the leading retailers of fine jewelry in the United
States. The Company operates leased fine jewelry Departments in major department
stores for retailers such as The May Department Stores Company ("May"),
Federated Department Stores ("Federated"), Belk, the Carson Pirie Scott division
of Saks Incorporated, Marshall Field's and Dillard's. Finlay sells a broad
selection of moderately priced fine jewelry, including necklaces, earrings,
bracelets, rings and watches, and markets these items principally as fashion
accessories with an average sales price of approximately $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 Company, a Delaware corporation incorporated on
November 22, 1988, was organized
3
by certain officers and directors of SL Holdings to acquire certain operations
of SL Holdings. In connection with a reorganization transaction in 1988, which
resulted in the merger of a wholly-owned subsidiary of the Company into SL
Holdings, SL Holdings changed its name to Finlay Fine Jewelry Corporation and
became a wholly-owned subsidiary of the Company. The Company is a holding
company and has no operations of its own. The primary asset of the Company is
the common stock of Finlay Jewelry, which conducts all of Finlay's operations.
The principal executive offices of the Company are located at 529 Fifth Avenue,
New York, New York 10017 and its telephone number at this address is (212)
808-2800.
GENERAL
OVERVIEW. Host stores benefit from outsourcing the operation of their fine
jewelry departments. By engaging Finlay, host stores gain specialized
managerial, merchandising, selling, marketing, inventory control and security
expertise. Additionally, by avoiding the high working capital investment
typically required of the jewelry business, host stores improve their return on
investment and can potentially increase their profitability.
As a lessee, Finlay benefits from the host stores' reputation, customer
traffic, advertising, credit services and established customer base. Finlay also
avoids the substantial capital investment in fixed assets typical of stand-alone
retail formats. These factors have generally enabled Finlay's new Departments to
achieve profitability within their first twelve months of operation. Finlay
further benefits because net sales proceeds are generally remitted to Finlay by
each host store on a monthly basis with essentially all customer credit risk
borne by the host store.
As a result of Finlay's strong relationships with its vendors, management
believes that the Company's working capital requirements are lower than those of
many other jewelry retailers. In recent years, on average, approximately 50% of
Finlay's 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 the Company's gift and special occasion sales. Finlay's
Departments are typically located in "high traffic" areas of leading department
stores, enabling Finlay to capitalize on these consumer buying patterns.
GROWTH STRATEGY. Finlay intends to continue to pursue the following key
initiatives to increase sales and earnings:
o INCREASE COMPARABLE DEPARTMENT SALES. 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.
4
o ADD DEPARTMENTS WITHIN EXISTING HOST STORE GROUPS. Finlay's well
established relationships with many of its host store groups have enabled
the Company to add Departments in new locations opened by existing host
stores. Finlay has operated Departments in May stores since 1948 and
operates in 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 the Company will
benefit from further investments in technology and refinements of operating
procedures designed to allow Finlay's sales associates more time for
customer sales and service. In March 2002, the Company implemented a new
merchandising and inventory control system and a point-of-sale system for
its Departments. These systems will provide the foundation for future
productivity and expense control initiatives. Further, Finlay's central
distribution facility has enabled the Company to improve the flow of
merchandise to Departments and to reduce payroll and freight costs.
MERCHANDISING STRATEGY. Finlay seeks to maximize sales and profitability
through a unique merchandising strategy known as the "Finlay Triangle", which
integrates store management (including host store management and Finlay's store
group management), vendors and Finlay's central office. By coordinating efforts
and sharing access to information, each Finlay Triangle participant plays a role
which emphasizes its area of expertise in the merchandising process, thereby
increasing productivity. Within guidelines set by the central office, Finlay's
store group management contributes to the selection of the specific merchandise
most appropriate to the demographics and customer tastes within their particular
geographical area. Finlay's advertising initiatives and promotional planning are
closely coordinated with both host store management and Finlay's store group
management to ensure the effective use of Finlay's marketing programs. Vendors
participate in the decision-making process with respect to merchandise
assortment, including the testing of new products, marketing, advertising and
stock levels. By utilizing the Finlay Triangle, opportunities are created for
the vendor to assist in identifying fashion trends thereby improving inventory
turnover and profitability, both for the vendor and Finlay. As a result,
management believes it capitalizes on economies of scale by centralizing certain
activities, such as vendor selection, advertising and planning, while allowing
store management the flexibility to implement merchandising programs tailored to
the host store environments and clientele.
5
THE FINLAY TRIANGLE
---------
CENTRAL
OFFICE
---------
--------- ----------
STORE
VENDORS 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 the Company's management information systems to monitor sales, gross
margin and inventory performance by location, merchandise category, style number
and vendor. Using this information, Finlay is able to monitor merchandise trends
and variances in performance and improve the efficiency of its inventory
management. Finlay also measures the productivity of its sales force by
maintaining current statistics for each employee such as sales per hour,
transactions per hour and transaction size. In March 2002, the Company
implemented a new merchandising and inventory control system and a point-of-sale
system for its Departments. These systems have provided improved analysis and
reporting capabilities and will serve to support future growth of the Company.
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 the Company's cost of goods sold in 2003. Under
such contracts, the Company obtains the right to purchase a fixed number of fine
troy ounces of gold at a specified price per ounce for a specified period. Such
contracts typically have durations ranging from one to nine months and are
generally priced at the spot gold price plus an amount based on prevailing
interest rates plus customary transactions costs. When sales of such merchandise
are reported to the consignment vendors and the cost of such merchandise becomes
fixed, Finlay sells its related hedge position. At January 31, 2004, the Company
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.
WEBSITE ACCESS TO THE COMPANY'S REPORTS
Finlay's internet address is www.finlayenterprises.com. Finlay makes
available free of charge on this website its annual report on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments
to those reports filed or furnished pursuant to Section 13(a) or 15(b) of the
Exchange Act, as soon as reasonably practicable after Finlay electronically
files such material with, or furnishes it to, the Securities and Exchange
Commission (the "Commission").
12
In addition, the Company provides, at no cost, paper or electronic copies
of its reports and other filings made with the Commission. Requests should be
directed to the Corporate Secretary at:
Finlay Enterprises, Inc.
529 Fifth Avenue
New York, NY 10017
The information on the website listed above, is not and should not be
considered part of this annual report on Form 10-K and is not incorporated by
reference in this document. This website is only intended to be an inactive
textual reference.
ITEM 2. PROPERTIES
The only real estate owned by Finlay is the central distribution facility,
totaling 106,200 square feet at 205 Edison Avenue, Orange, Connecticut. Finlay
leases approximately 18,400 square feet at 521 Fifth Avenue, New York, New York,
and 49,100 square feet at 529 Fifth Avenue, New York, New York for its
executive, accounting, advertising, the majority of its data processing
operations and other administrative functions. The leases for such space expire
September 30, 2008. Generally, as part of Finlay's lease arrangements, host
stores provide office space to Finlay's host store group management personnel
free of charge.
ITEM 3. LEGAL PROCEEDINGS
From time to time, Finlay is involved in litigation relating to claims
arising out of its operations in the normal course of business. As of April 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
The common stock, par value $.01 per share ("Common Stock"), of the Company
is traded on the Nasdaq National Market under the symbol "FNLY". The high and
low sales prices for the Common Stock during 2003 and 2002 were as follows:
FISCAL YEAR ENDED
-------------------------------------------------------
JANUARY 31, 2004 FEBRUARY 1, 2003
------------------------ --------------------------
HIGH LOW HIGH LOW
---------- ---------- ----------- -----------
First Quarter................................. $ 15.30 $ 9.90 $ 14.75 $ 9.31
Second Quarter................................ 17.40 11.79 18.80 12.66
Third Quarter................................. 17.85 13.85 18.99 11.60
Fourth Quarter................................ 17.77 13.87 15.00 10.50
The Company has never paid cash dividends on its Common Stock and has no
present intention to pay any cash dividends in the foreseeable future. Certain
restrictive covenants in the indenture relating to Finlay Jewelry's $150.0
million aggregate principal amount of 83/8% Senior Notes due May 1, 2008 (the
"Senior Notes") (the "Senior Note Indenture") and the indenture relating to the
Company's $75.0 million aggregate principal amount of 9% Senior Debentures due
May 1, 2008 (the "Senior Debentures") (the "Senior Debenture Indenture", and
collectively with the Senior Note Indenture, the "Senior Indentures"), the
Revolving Credit Agreement and the Gold Consignment Agreement impose limitations
on the payment of dividends by the Company (including Finlay Jewelry's ability
to pay dividends to the Company). Additionally, the Revolving Credit Agreement,
the Senior Note Indenture and the Gold Consignment Agreement currently restrict
annual distributions from Finlay Jewelry to the Company to 0.25% of Finlay
Jewelry's net sales for the preceding fiscal year and allow distributions to the
Company to enable it to make interest payments on the Senior Debentures. Other
dividends and distributions, including those required to fund stock or bond
repurchases, are subject to Finlay's satisfaction of certain restrictive
covenants.
During 2003, cash dividends of $13.5 million were distributed by Finlay
Jewelry to the Company. The distributions are generally utilized to pay interest
on the Senior Debentures and certain expenses of the Company, such as legal,
accounting and directors' fees and to purchase Common Stock under the stock
repurchase program described below.
Information regarding the Company's equity compensation plans is set forth
in Item 12 of Part III of this Form 10-K, which information is incorporated
herein by reference.
As of April 9, 2004, there were 10,826,871 shares of Common Stock
outstanding and approximately 53 record holders of the Common Stock, including
holders who are nominees for an undetermined number of beneficial owners,
estimated to be in excess of 500. The last reported sale price for the Common
Stock on the Nasdaq National Market on April 9, 2004 was $17.63.
14
ISSUER PURCHASES OF EQUITY SECURITIES
The following table sets forth certain information with respect to
repurchases of equity securities by the Company during the fourth quarter of
2003:
(C) (D)
TOTAL NUMBER OF APPROXIMATE DOLLAR
(A) (B) SHARES PURCHASED AS VALUE OF SHARES THAT
TOTAL NUMBER OF AVERAGE PRICE PART OF PUBLICLY MAY YET BE PURCHASED
PERIOD SHARES PURCHASED (1) PAID PER SHARE ANNOUNCED PLANS UNDER THE PLANS
------------------- -------------------- ---------------- -------------------- ----------------------
November 2, 2003 -
November 29, 2003 13,705 $ 15.83 13,705 $ 20,971,998
November 30, 2003 -
January 3, 2004 46,249 $ 14.88 46,249 $ 20,283,969
January 4, 2004 -
January 31, 2004 52,025 $ 15.78 52,025 $ 19,463,003
------- -------
Total 111,979 111,979
======= =======
- -----------------
(1) All shares were repurchased through the Company's publicly announced stock
repurchase program.
On December 1, 2000, the Company announced that its Board of Directors had
approved a stock repurchase program to acquire up to $20 million of Common
Stock. The stock repurchase program has been extended from time to time and, on
June 19, 2003, the Company's Board of Directors approved the repurchase of an
additional $20 million of outstanding Common Stock. The Company may, at the
discretion of management, purchase its Common Stock, from time to time through
September 29, 2004 under the stock repurchase program. The extent and timing of
repurchases will depend upon general business and market conditions, stock
prices, availability under the Revolving Credit Facility, compliance with
certain restrictive covenants and its cash position and requirements going
forward. As of January 31, 2004, the Company repurchased a total of 1,815,000
shares for $20.5 million. During 2003, 2002 and 2001, the Company repurchased
482,217, 733,612 and 507,330 shares for $6.7 million, $8.4 million and $4.2
million, respectively.
15
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 the Company'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, EXCEPT PER SHARE DATA)
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........ 388,349 378,855 374,866 389,576 359,852
(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.............................. 56,524 58,200 53,168 69,244 31,867
Interest expense, net............................... 23,506 24,627 26,583 29,503 28,983
------------ ----------- ------------- ------------ ----------
Income from continuing operations before
income taxes and cumulative effect of
accounting change............................... 33,018 33,573 26,585 39,741 2,884
Provision for income taxes.......................... 13,071 13,135 11,432 17,080 2,432
------------ ----------- ------------- ------------ ----------
Income from continuing operations before
cumulative effect of accounting change............ 19,947 20,438 15,153 22,661 452
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......................................... $ 8,410 $ 7,039 $ 18,535 $ 26,521 $ 4,063
============ =========== ============= ============ ==========
Net income per share applicable to
common shares:
Basic net income per share:
Income from continuing operations before
cumulative effect of accounting change.... $ 2.21 $ 2.17 $ 1.49 $ 2.17 $ 0.04
Discontinued operations...................... (1.28) 0.41 0.33 0.37 0.35
Cumulative effect of accounting change....... - (1.83) - - -
------------ ----------- ------------- ------------ ----------
Net income................................... $ 0.93 $ 0.75 $ 1.82 $ 2.54 $ 0.39
============ =========== ============= ============ ==========
Diluted net income per share:
Income from continuing operations before
cumulative effect of accounting change ... $ 2.15 $ 2.11 $ 1.47 $ 2.16 $ 0.04
Discontinued operations...................... (1.24) 0.40 0.33 0.36 0.35
Cumulative effect of accounting change....... - (1.78) - - -
------------ ----------- ------------- ------------ ----------
Net income...................................... $ 0.91 $ 0.73 $ 1.80 $ 2.52 $ 0.39
============ =========== ============= ============ ==========
Weighted average number of shares and share
equivalents outstanding (000's):
Basic........................................ 9,012 9,416 10,180 10,421 10,413
Diluted...................................... 9,292 9,683 10,301 10,508 10,504
16
FISCAL YEAR ENDED (1)
-------------------------------------------------------------------------
JAN. 31, FEB. 1, FEB. 2, FEB. 3, JAN. 29,
2004 2003 2002 2001 2000
------------ ----------- ------------- ------------ ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
PRO FORMA DOMESTIC STATEMENT OF
OPERATIONS DATA (6):
Sales........................................... $ 902,416 $ 877,296 $ 900,628 $ 944,756 $ 834,614
EBITDA (7) ..................................... $ 73,550 $ 73,595 $ 72,516 $ 86,122 $ 79,986
Net income...................................... $ 19,947 $ 19,586 $ 15,153 $ 22,661 $ 21,005
Net income per share applicable
to common shares:
Basic net income per share.................... $ 2.21 $ 2.08 $ 1.49 $ 2.17 $ 2.02
Diluted net income per share.................. $ 2.15 $ 2.02 $ 1.47 $ 2.16 $ 2.00
OPERATING AND FINANCIAL DATA:
Number of Departments (end of year).............. 972 1,011 1,006 1,053 987
Percentage increase (decrease) in sales (8)...... 2.9% (2.6)% (4.7)% 9.7% 5.7%
Percentage increase (decrease) in domestic
comparable Department sales (9) ............. 2.3% 0.1% (3.0)% 2.1% 8.1%
Average domestic sales per Department (10)....... $ 932 $ 911 $ 916 $ 970 $ 929
EBITDA (7)....................................... 73,550 75,027 72,516 86,122 48,179
Capital expenditures............................. 12,934 12,489 13,850 18,118 14,972
CASH FLOWS PROVIDED FROM (USED IN):
Operating activities............................. $ 41,183 $ 45,060 $ 40,231 $ 27,860 $ 38,804
Investing activities............................. (12,934) (15,750) (17,432) (30,403) (21,054)
Financing activities............................. (6,278) (9,348) (5,092) (981) 137
BALANCE SHEET DATA-END OF PERIOD:
Working capital.................................. $ 238,333 $ 208,990 $ 202,536 $ 180,274 $ 157,587
Total assets..................................... 595,022 580,485 584,853 604,143 557,042
Short-term debt, including current portion of
long-term debt................................ - - - - -
Long-term debt................................... 225,000 225,000 225,000 225,000 225,000
Total stockholders' equity....................... 152,896 149,036 149,207 134,340 108,800
- ------------------
(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,
the Company'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 the Company'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"), the Company recorded a cumulative
effect of accounting change as of February 3, 2002, the date of adoption,
that decreased net income for 2002 by $17.2 million, net of tax of $11.7
million, or $1.78 per share, on a diluted basis. The application of EITF
02-16 changed the Company'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) The pro forma financial information reflects the Company's domestic
operations only and excludes the operations of Sonab, as well as the impact
of the sale and closure of Sonab. Additionally, the pro forma financial
information excludes the impact of the discontinued operations of the
Burdines Departments, described in Note 4 above. The pro forma financial
information for 2002 excludes the Company's adoption of EITF 02-16,
described in Note 5 above. The pro forma financial information was
calculated as follows:
17
FISCAL YEAR ENDED
-----------------------------------------------------------------------------
JAN. 31, FEB. 1, FEB. 2, FEB. 3, JAN. 29,
2004 2003 2002 2001 2000
--------------- ----------- ------------ ------------ ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SALES:
Reported sales............................. $ 902,416 $ 877,296 $ 900,628 $ 944,756 $ 861,369
Less: Sonab sales.......................... - - - - (26,755)
--------------- ----------- ------------ ------------ ----------
Pro forma sales............................ $ 902,416 $ 877,296 $ 900,628 $ 944,756 $ 834,614
=============== =========== ============ ============ ==========
EBITDA:
Income from operations..................... $ 56,524 $ 58,200 $ 53,168 $ 69,244 $ 31,867
Add: Depreciation and amortization......... 17,026 16,827 19,348 16,878 16,312
--------------- ----------- ------------ ------------ ----------
Consolidated EBITDA........................ 73,550 75,027 72,516 86,122 48,179
Add: Sonab operating loss ................. - - - - 3,808
Less: Sonab depreciation and amortization - - - - (632)
--------------- ----------- ------------ ------------ ----------
Domestic EBITDA............................ 73,550 75,027 72,516 86,122 51,355
Add: (Credit) charges associated with
sale and closure of Sonab............... - (1,432) - - 28,631
--------------- ----------- ------------ ------------ ----------
Pro forma EBITDA........................... $ 73,550 $ 73,595 $ 72,516 $ 86,122 $ 79,986
=============== =========== ============ ============ ==========
NET INCOME:
Reported net income........................ $ 8,410 $ 7,039 $ 18,535 $ 26,521 $ 4,063
Add: Cumulative effect of accounting
change, net of tax.................... - 17,209 - - -
Less: Discontinued operations, net of tax.. (11,537) 3,810 3,382 3,860 3,611
Add: Sonab net loss....................... - - - - 3,517
Add: (Credit) charges associated with
sale and closure of Sonab, net.......... - (852) - - 17,036
--------------- ----------- ------------ ------------ ----------
Pro forma net income....................... $ 19,947 $ 19,586 $ 15,153 $ 22,661 $ 21,005
=============== =========== ============ ============ ==========
BASIC NET INCOME PER SHARE:
Reported net income per share.............. $ 0.93 $ 0.75 $ 1.82 $ 2.54 $ 0.39
Add: Cumulative effect of accounting
change, net of tax.................... - 1.83 - - -
Less: Discontinued operations, net of tax.. (1.28) 0.41 0.33 0.37 0.35
Add: Sonab net loss........................ - - - - 0.34
Add: (Credit) charges associated with the
sale and closure of Sonab, net.......... - (0.09) - - 1.64
--------------- ----------- ------------ ------------ ----------
Pro forma net income per share............. $ 2.21 $ 2.08 $ 1.49 $ 2.17 $ 2.02
=============== =========== ============ ============ ==========
DILUTED NET INCOME PER SHARE:
Reported net income per share.............. $ 0.91 $ 0.73 $ 1.80 $ 2.52 $ 0.39
Add: Cumulative effect of accounting
change, net of tax.................... - 1.78 - - -
Less: Discontinued operations, net of tax.. (1.24) 0.40 0.33 0.36 0.35
Add: Sonab net loss........................ - - - - 0.34
Add: (Credit) charges associated with the
sale and closure of Sonab, net.......... - (0.09) - - 1.62
--------------- ----------- ------------ ------------ ----------
Pro forma net income per share............. $ 2.15 $ 2.02 $ 1.47 $ 2.16 $ 2.00
=============== =========== ============ ============ ==========
The Company believes that the pro forma statement of operations data
presents, on a comparable basis, the Company's domestic results of
operations and provides additional information for analyzing the Company's
operating performance. This presentation should not be construed as a
substitute for income from continuing operations, net income or cash flow
from operating activities (all as determined in accordance with generally
accepted accounting principles ("GAAP")) for the purpose of analyzing
Finlay's operating performance, financial position and cash flows as this
presentation is not defined by GAAP. Finlay has presented this information,
because it is commonly used by certain investors to compare companies on
the basis of consistent performance.
(7) 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:
18
FISCAL YEAR ENDED
--------------------------------------------------------------------------
JAN. 31, FEB. 1, FEB. 2, FEB. 3, JAN. 29,
2004 2003 2002 2001 2000
------------ ---------- ------------- ----------- ------------
(DOLLARS IN THOUSANDS)
Income from operations................. $ 56,524 $ 58,200 $ 53,168 $ 69,244 $ 31,867
Add: Depreciation and amortization..... 17,026 16,827 19,348 16,878 16,312
------------ ---------- ------------- ----------- ------------
EBITDA................................. $ 73,550 $ 75,027 $ 72,516 $ 86,122 $48,179
============ ========== ============= =========== ============
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.
(8) 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%.
(9) Comparable Department sales are calculated by comparing the domestic sales
from Departments open for the same months in the comparable periods.
(10) Average domestic sales per Department is determined by dividing domestic
sales by the average of the number of domestic Departments open at the
beginning and at the end of each period.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following 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
the Company's business and a brief discussion of the opportunities,
challenges and risks that the Company 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 the
Company's business.
o CRITICAL ACCOUNTING POLICIES AND ESTIMATES - This section discusses
those accounting policies that both are considered important to
Finlay's financial condition and results of operations, and require
Finlay to exercise subjective or complex judgments in their
application. In addition, all of Finlay'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 the Company'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
the Company's continuing operations.
EXECUTIVE OVERVIEW
OUR BUSINESS
The Company 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, the Company 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 the Company 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
20
investment 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.
The Company 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 Diluted earnings per share ("EPS") (net income divided by weighted
average shares outstanding with options to purchase common stock,
restricted stock and restricted stock units, included to the extent
they are dilutive) which, when compared to prior year, is an indicator
of the increased returns generated for the Company's shareholders;
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
the Company'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
the Company'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 the Company'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 the Company's 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 $9.5 million, as a percentage of sales, SG&A decreased 0.2% from 43.2%
to 43.0%.
During 2003, the Company effectively managed its inventories and
implemented appropriate expense controls. Finlay's continued focus on cash
management enabled the Company to end 2003 with $91.3 million of cash compared
to $69.3 million at the end of 2002. Finlay's operating cash flow was $41.2
million in 2003, which enabled Finlay to open new Departments, remodel and
expand existing Departments and repurchase stock. 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.
21
OUTLOOK
The Company 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;
o De-leverage the balance sheet; and
o Continue its stock repurchase program.
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, the Company 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, the
Company 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
22
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.
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. The Company 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 the Company. 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.
The Company is currently evaluating the potential refinancing of the Senior
Debentures and the Senior Notes. The Company's 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 the Company, 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............. 43.0 43.2 41.6
Credit associated with the sale and
closure of Sonab...................................... - (0.1) -
Depreciation and amortization............................ 1.9 1.9 2.2
------------ ------------- ------------
Income from operations................................... 6.3 6.6 5.9
Interest expense, net.................................... 2.6 2.8 2.9
------------ ------------- ------------
Income from continuing operations before income
taxes and cumulative effect of accounting change..... 3.7 3.8 3.0
Provision for income taxes............................... 1.5 1.5 1.3
------------ ------------- ------------
Income from continuing operations before
cumulative effect of accounting change............... 2.2 2.3 1.7
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............................................... 0.9% 0.8% 2.1%
============ ============= ============
- ----------------------
(1) See Note 4 to "Selected Consolidated Financial Data".
(2) See Note 5 to "Selected Consolidated Financial Data".
23
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 the Company'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 $9.5 million, or 2.5%. As a
percentage of sales, SG&A decreased to 43.0% from 43.2%. The components of this
0.2% net decrease in SG&A are as follows:
24
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 ($267.7 million for 2003 compared to
$286.2 million for 2002). The weighted average interest rate was approximately
7.7% for 2003 compared to 7.6% for 2002.
PROVISION FOR INCOME TAXES. The income tax provision for 2003 and 2002
reflects effective tax rates of 39.6% and 39.1%, 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 $8.4 million for 2003 represents an increase of
$1.4 million as compared to net income of $7.0 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 the Company's adoption of EITF 02-16. The application of EITF 02-16
changed the Company's accounting treatment for the recognition of vendor
allowances. In 2002, $18.9 million of vendor allowances has been reflected as a
reduction to cost
25
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 $378.9 million,
an increase of $4.0 million, or 1.1%, in 2002 compared to 2001, primarily due to
the Company'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 43.2%
in 2002 from 41.6% 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 the Company's sales and reduced gross
advertising expenses. Additionally, the Company recorded a $1.8 million
reduction in employee medical benefits expense associated with favorable claims
experience subsequent to a change in medical insurance carriers. SG&A as a
percentage of sales, excluding the adoption of EITF 02-16, decreased to 41.0% in
2002 from 41.6% in 2001.
CREDIT ASSOCIATED WITH THE SALE AND CLOSURE OF SONAB. In 2002, the Company
revised its 1999 estimate of closure expenses to reflect its remaining liability
associated with the closure of Sonab and, as a result, recorded a credit of $1.4
million.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased by
$2.5 million in 2002 compared to 2001, reflecting the discontinuance of goodwill
amortization of $3.7 million and the effect of certain assets becoming fully
depreciated, offset by additional depreciation and amortization as a result of
capital expenditures and capitalized software costs for the most recent twelve
months.
INTEREST EXPENSE, NET. Interest expense decreased by $2.0 million
reflecting a lower weighted average interest rate (7.6% for 2002 compared to
7.8% for 2001) and a decrease in average borrowings ($286.2 million for 2002
compared to $305.8 million for 2001).
PROVISION FOR INCOME TAXES. The effective tax rate, before the cumulative
effect of accounting change, decreased to 39.1% in 2002 from 42.6% in 2001,
primarily as a result of the cessation in 2002 of the amortization of
non-deductible goodwill.
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. The Company elected
to adopt EITF 02-16 retroactive to the beginning of 2002 and recorded a
cumulative effect after-tax reduction to earnings of $17.2 million. The charge
relates to the deferral of a portion of the Company's previously collected
vendor allowances relating to both owned merchandise and merchandise received on
consignment.
NET INCOME. Net income of $7.0 million for 2002 represents a decrease of
$11.5 million as compared to net income of $18.5 million in 2001 as a result of
the factors discussed above.
26
LIQUIDITY AND CAPITAL RESOURCES
Information about the Company'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......... $ 91,302 $ 69,331
Working capital................... 238,333 208,990
Long-term debt.................... 225,000 225,000
Stockholders' equity.............. 152,896 149,036
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 the Company from
satisfying its capital expenditure requirements.
The Company currently expects to fund capital expenditure requirements as
well as liquidity needs from a combination of cash, internally generated funds
and financing arrangements. The Company 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........................ $ 41,183 $ 45,060 $ 40,231
Investing Activities........................ (12,934) (15,750) (17,432)
Financing Activities........................ (6,278) (9,348) (5,092)
--------------- -------------- --------------
Total Cash Provided from Operations.. $ 21,971 $ 19,962 $ 17,707
=============== ============== ==============
The Company'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;
o Strategic acquisitions; and
o Stock repurchases under the Company's stock repurchase program.
OPERATING ACTIVITIES
The primary source of the Company'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 $41.2 million for 2003, a
decrease
27
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 the Company's increase in sales.
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. The Company's working capital balance was $238.3 million
at January 31, 2004, an increase of $29.3 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 purchase of treasury stock.
The seasonality of Finlay's business causes working capital requirements,
and therefore borrowings under the Revolving Credit Agreement, to reach their
highest level in the months of October, November and December in anticipation of
the year-end holiday season. Accordingly, Finlay experiences seasonal cash needs
as inventory levels peak. Additionally, substantially all of Finlay's lease
agreements provide for accelerated payments during the months of November and
December, which require the host store groups to remit to Finlay 75% of the
estimated months' sales prior to or shortly following the end of that month.
These proceeds result in a significant increase in the Company's cash, which is
used to reduce the Company's borrowings under the Revolving Credit Agreement.
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 stock repurchases have been the Company's primary
financing activities. Net cash used in financing activities was $6.3 million in
2003, consisting principally of the repurchase of 482,217 shares of Common Stock
for approximately $6.7 million under its stock repurchase program, partially
offset by funds received from stock option exercises. Net cash used in financing
activities was $9.3 million in 2002 principally related to the repurchase of
733,612 shares for approximately $8.4 million under the stock repurchase program
and capitalized financing costs of approximately $1.9 million related to the
Company's refinancing of its Revolving Credit Agreement. Net cash used in
financing activities was $5.1 million in 2001 primarily related to the
repurchase of 507,330 shares for approximately $4.2 million under the stock
repurchase program.
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 the Company. 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
28
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.
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's outstanding borrowings were $225.0
million, which included a $75.0 million balance under the Senior Debentures and
a $