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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
--- THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended July 31, 2004
or
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _________ to __________
Commission File Number: 0-25716
FINLAY ENTERPRISES, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3492802
- ------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
529 Fifth Avenue, New York, NY 10017
---------------------------------------- ----------
(Address of principal executive offices) (zip code)
(212) 808-2800
------------------------------------------------------
(Registrant's telephone number, including area code)
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
--- ---
As of September 3, 2004, there were 8,858,809 shares of common stock, par value
$.01 per share, of the registrant outstanding.
FINLAY ENTERPRISES, INC.
FORM 10-Q
QUARTERLY PERIOD ENDED JULY 31, 2004
INDEX
PAGE(S)
-------
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Statements of Operations for the
thirteen weeks and twenty-six weeks ended
July 31, 2004 and August 2, 2003.................................1
Consolidated Balance Sheets as of July 31, 2004 and
January 31, 2004.................................................3
Consolidated Statements of Changes in Stockholders'
Equity for the year ended January 31, 2004 and the
twenty-six weeks ended July 31, 2004.............................4
Consolidated Statements of Cash Flows for the thirteen
weeks and twenty-six weeks ended July 31, 2004
and August 2, 2003...............................................5
Notes to Consolidated Financial Statements.......................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...................17
Item 3. Quantitative and Qualitative Disclosures about Market Risk......32
Item 4. Controls and Procedures.........................................32
PART II - OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities............................................34
Item 4. Submission of Matters to a Vote of Security Holders.............34
Item 6. Exhibits and Reports on Form 8-K................................34
SIGNATURES....................................................................37
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
THIRTEEN WEEKS ENDED
------------------------------------
JULY 31, AUGUST 2,
2004 2003
--------------- ---------------
Sales.................................................................... $ 188,638 $ 182,229
Cost of sales............................................................ 93,177 89,433
--------------- ---------------
Gross margin......................................................... 95,461 92,796
Selling, general and administrative expenses............................. 87,286 84,346
Depreciation and amortization............................................ 4,374 4,177
--------------- ---------------
Income from operations............................................... 3,801 4,273
Interest expense, net.................................................... 5,802 5,930
Other expense - debt extinguishment costs................................ 9,090 -
--------------- ---------------
Loss from continuing operations before income taxes.................. (11,091) (1,657)
Benefit for income taxes................................................. (4,950) (645)
--------------- ---------------
Loss from continuing operations...................................... (6,141) (1,012)
Discontinued operations, net of tax...................................... - 450
--------------- ---------------
Net loss............................................................. $ (6,141) $ (562)
=============== ===============
Net loss per share applicable to common shares - basic and diluted:
Loss from continuing operations................................ $ (0.71) $ (0.11)
Discontinued operations, net of tax............................ - 0.05
--------------- ---------------
Net loss....................................................... $ (0.71) $ (0.06)
=============== ===============
Weighted average shares outstanding -
basic and diluted............................................... 8,644,967 9,021,053
=============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
1
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
TWENTY-SIX WEEKS ENDED
------------------------------------
JULY 31, AUGUST 2,
2004 2003
--------------- ---------------
Sales.................................................................... $ 376,210 $ 357,656
Cost of sales............................................................ 185,512 174,094
--------------- ---------------
Gross margin......................................................... 190,698 183,562
Selling, general and administrative expenses............................. 175,467 168,530
Depreciation and amortization............................................ 8,763 8,365
--------------- ---------------
Income from operations............................................... 6,468 6,667
Interest expense, net.................................................... 11,513 11,706
Other expense - debt extinguishment costs................................ 9,090 -
--------------- ---------------
Loss from continuing operations before income taxes................. (14,135) (5,039)
Benefit for income taxes................................................. (6,137) (1,963)
--------------- ---------------
Loss from continuing operations..................................... (7,998) (3,076)
Discontinued operations, net of tax...................................... - 1,061
--------------- ---------------
Net loss............................................................ $ (7,998) $ (2,015)
=============== ===============
Net loss per share applicable to common shares - basic and diluted:
Loss from continuing operations............................. $ (0.92) $ (0.34)
Discontinued operations, net of tax......................... - 0.12
--------------- ---------------
Net loss per share.......................................... $ (0.92) $ (0.22)
=============== ===============
Weighted average shares outstanding -
basic and diluted.............................................. 8,719,645 9,079,077
=============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
2
FINLAY ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
JULY 31, JANUARY 31,
2004 2004
------------- --------------
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 1,802 $ 91,302
Accounts receivable - department stores...................................... 36,185 21,602
Other receivables............................................................ 58,196 38,457
Merchandise inventories...................................................... 279,233 272,948
Prepaid expenses and other................................................... 3,742 2,616
Deferred income taxes........................................................ - 6,564
------------- --------------
Total current assets...................................................... 379,158 433,489
------------- --------------
Fixed assets:
Building, equipment, fixtures and leasehold improvements..................... 122,065 117,631
Less - accumulated depreciation and amortization............................. 57,942 51,506
------------- --------------
Fixed assets, net......................................................... 64,123 66,125
------------- --------------
Deferred charges and other assets, net......................................... 19,034 18,120
Goodwill....................................................................... 77,288 77,288
------------- --------------
Total assets.............................................................. $ 539,603 $ 595,022
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings........................................................ $ 59,968 $ -
Accounts payable - trade..................................................... 49,505 122,976
Accrued liabilities:
Accrued salaries and benefits............................................. 13,289 18,756
Accrued miscellaneous taxes............................................... 6,919 7,180
Accrued interest.......................................................... 3,368 5,303
Deferred income........................................................... 8,116 9,515
Deferred income taxes..................................................... 3,564 -
Other..................................................................... 16,490 15,864
Income taxes payable......................................................... 12,289 15,562
------------- --------------
Total current liabilities................................................. 173,508 195,156
Long-term debt................................................................. 200,000 225,000
Deferred income taxes.......................................................... 23,477 21,890
Other non-current liabilities.................................................. 71 80
------------- --------------
Total liabilities......................................................... 397,056 442,126
------------- --------------
Stockholders' equity:
Common Stock, par value $.01 per share; authorized 25,000,000 shares; issued
11,045,246 and 10,833,080 shares, at July 31, 2004 and
January 31, 2004, respectively............................................ 110 108
Additional paid-in capital .................................................. 88,067 82,808
Retained earnings............................................................ 84,009 92,007
Unamortized restricted stock compensation.................................... (2,157) (1,405)
Accumulated other comprehensive loss......................................... (83) (85)
Less treasury stock, of 2,207,904 and 1,815,159, respectively, at cost....... (27,399) (20,537)
------------- --------------
Total stockholders' equity................................................ 142,547 152,896
------------- --------------
Total liabilities and stockholders' equity................................ $ 539,603 $ 595,022
============= ==============
The accompanying notes are an integral part of these
consolidated financial statements.
3
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
COMMON STOCK UNAMORTIZED ACCUMULATED
------------------- ADDITIONAL RESTRICTED OTHER TOTAL
NUMBER OF PAID-IN RETAINED STOCK COMPREHENSIVE TREASURY STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS COMPENSATION INCOME STOCK EQUITY
--------- --------- ---------- -------- ------------ ------------- ---------- -------------
Balance, February 1, 2003........... 9,300,638 $ 106 $ 79,680 $ 83,597 $ (609) $ 55 $ (13,793) $ 149,036
Net income........................ - - - 8,410 - - - 8,410
Change in fair value of gold
forward contracts, net of tax.. - - - - - (140) - (140)
Exercise of stock options and
related tax benefit............ 149,500 1 1,722 - - - - 1,722
Issuance of restricted stock and
restricted stock units ........ 50,000 1 1,406 - (1,327) - - 80
Amortization of restricted stock
compensation and restricted
stock units.................... - - - - 531 - - 531
Purchase of treasury stock ....... (482,217) - - - - - (6,744) (6,744)
--------- --------- ---------- -------- ------------ ------------- ---------- -------------
Balance, January 31, 2004........... 9,017,921 108 82,808 92,007 (1,405) (85) (20,537) 152,896
Net loss.......................... - - - (7,998) - - - (7,998)
Change in fair value of gold
forward contracts, net of tax.. - - - - - 2 - 2
Exercise of stock options
and related tax benefits....... 212,166 2 3,170 - - - - 3,172
Issuance of restricted stock and
restricted stock units......... - - 2,089 - (1,361) - - 728
Amortization of restricted stock
compensation and restricted
stock units.................... - - - - 609 - - 609
Purchase of treasury stock........ (392,745) - - - - - (6,862) (6,862)
--------- --------- ---------- -------- ------------ ------------- ---------- -------------
Balance, July 31, 2004.............. 8,837,342 $ 110 $ 88,067 $ 84,009 $ (2,157) $ (83) $ (27,399) $ 142,547
========= ========= ========== ======== ============ ============= ========== =============
The accompanying notes are an integral part of these
consolidated financial statements.
4
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THIRTEEN WEEKS ENDED
-----------------------------
JULY 31, AUGUST 2,
2004 2003
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ............................................................ $ (6,141) $ (562)
Adjustments to reconcile net loss to net cash provided from (used in)
operating activities:
Depreciation and amortization ...................................... 4,374 4,353
Amortization of deferred financing costs ........................... 279 259
Amortization of restricted stock compensation
and restricted stock units ..................................... 374 76
Loss on extinguishment of debt ..................................... 9,090 --
Deferred income tax provision ...................................... 11,334 (1,327)
Other, net .......................................................... 481 446
Changes in operating assets and liabilities:
(Increase) decrease in accounts and other receivables ............ (10,814) 6,581
Decrease in merchandise inventories .............................. 15,204 15,079
(Increase) decrease in prepaid expenses and other ................ 1,059 (795)
Decrease in accounts payable and accrued liabilities ............. (39,925) (15,417)
--------- ---------
NET CASH PROVIDED FROM (USED IN) OPERATING
ACTIVITIES ................................................ (14,685) 8,693
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment, fixtures and leasehold improvements ......... (2,515) (2,084)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES ......................... (2,515) (2,084)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility ............................. 199,679 147,026
Principal payments on revolving credit facility ..................... (153,249) (149,471)
Proceeds from issuance of New Senior Notes .......................... 200,000 --
Purchase and redemption of Senior Debentures and Senior Notes ....... (231,971) --
Capitalized financing costs ......................................... (4,771) --
Bank overdraft ...................................................... 2,698 (3,335)
Purchase of treasury stock .......................................... -- (1,047)
Stock options exercised ............................................. 1,444 --
--------- ---------
NET CASH PROVIDED FROM (USED IN) FINANCING
ACTIVITIES .............................................. 13,830 (6,827)
--------- ---------
DECREASE IN CASH AND CASH EQUIVALENTS ...................... (3,370) (218)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ........................ 5,172 2,585
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD .............................. $ 1,802 $ 2,367
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid ..................................................... $ 12,334 $ 934
========= =========
Income taxes paid (refunded) ...................................... $ (1,096) $ 2,426
========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
5
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
TWENTY-SIX WEEKS ENDED
-----------------------------
JULY 31, AUGUST 2,
2004 2003
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss .................................................................. $ (7,998) $ (2,015)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ............................................. 8,763 8,719
Amortization of deferred financing costs .................................. 537 517
Amortization of restricted stock compensation and
restricted stock units ............................................... 609 152
Loss on extinguishment of debt ............................................ 9,090 --
Deferred income tax provision ............................................. 11,715 1,937
Other, net ................................................................ 516 414
Changes in operating assets and liabilities:
Increase in accounts and other receivables ............................ (34,322) (19,490)
Increase in merchandise inventories ................................... (6,285) (1,247)
Increase in prepaid expenses and other ................................ (1,126) (2,464)
Decrease in accounts payable and accrued liabilities .................. (96,543) (87,896)
--------- ---------
NET CASH USED IN OPERATING ACTIVITIES .............................. (115,044) (101,373)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment, fixtures and leasehold improvements ............... (5,635) (5,030)
Deferred charges and other, net ........................................... -- 23
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES ............................... (5,635) (5,007)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility ................................... 329,516 306,484
Principal payments on revolving credit facility ........................... (269,548) (272,712)
Proceeds from issuance of New Senior Notes ................................ 200,000 --
Purchase and redemption of Senior Debentures and Senior Notes ............. (231,971) --
Capitalized financing costs ............................................... (4,771) (431)
Bank overdraft ............................................................ 12,220 8,677
Purchase of treasury stock ................................................ (6,862) (2,848)
Stock options exercised ................................................... 2,595 246
--------- ---------
NET CASH PROVIDED FROM FINANCING ACTIVITIES ...................... 31,179 39,416
--------- ---------
DECREASE IN CASH AND CASH EQUIVALENTS ............................ (89,500) (66,964)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .............................. 91,302 69,331
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD .................................... $ 1,802 $ 2,367
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid ........................................................... $ 12,911 $ 11,395
========= =========
Income taxes paid ....................................................... $ 3,274 $ 7,685
========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
6
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF ACCOUNTING AND PRESENTATION
The accompanying unaudited consolidated financial statements of Finlay
Enterprises, Inc. (the "Company," the "Registrant," "we," "us" and "our"), and
its wholly-owned subsidiary, Finlay Fine Jewelry Corporation and its
wholly-owned subsidiaries ("Finlay Jewelry"), have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information. References to "Finlay" mean collectively, the
Company and Finlay Jewelry. In the opinion of management, the accompanying
unaudited consolidated financial statements contain all adjustments necessary to
present fairly our financial position as of July 31, 2004, and our results of
operations and cash flows for the thirteen weeks and twenty-six weeks ended July
31, 2004 and August 2, 2003. Due to the seasonal nature of the business, results
for interim periods are not indicative of annual results. The unaudited
consolidated financial statements have been prepared on a basis consistent with
that of the audited consolidated financial statements as of January 31, 2004
referred to below. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to the rules and regulations of the Securities and
Exchange Commission (the "Commission").
These consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto included in our
Annual Report on Form 10-K, as amended, for the fiscal year ended January 31,
2004 ("Form 10-K") previously filed with the Commission.
The results of operations and related disclosures for the thirteen weeks
and twenty-six weeks ended August 2, 2003 reflect the Burdines departments as a
discontinued operation. See Note 11 for additional information regarding
discontinued operations.
Our fiscal year ends on the Saturday closest to January 31. References to
2004, 2003, 2002 and 2001 relate to the fiscal years ending January 29, 2005,
January 31, 2004, February 1, 2003 and February 2, 2002, respectively. Each of
the fiscal years includes 52 weeks.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
MERCHANDISE INVENTORIES: Consolidated inventories are stated at the lower
of cost or market determined by the last-in, first-out ("LIFO") method.
Inventory is reduced for estimated obsolescence or unmarketable inventory equal
to the difference between the cost of inventory and the estimated market value
based upon assumptions about future demand and market conditions.
The cost to us of gold merchandise sold on consignment, which typically
varies with the price of gold, is not fixed until the merchandise is sold. We,
at times, enter into forward contracts based upon the anticipated sales of gold
product in order to hedge against the risk of gold price fluctuations. Such
contracts typically have durations ranging from one to nine months. At both July
31, 2004 and January 31, 2004, we had several open positions in gold forward
contracts totaling 54,500 fine troy ounces and 25,000 fine troy ounces,
respectively, to purchase gold for $21.7 million and $10.2 million,
respectively. The fair value of gold under such contracts was $21.5 million and
$10.0 million at July 31, 2004 and January 31, 2004, respectively.
VENDOR ALLOWANCES: We receive allowances from our vendors through a
variety of programs and arrangements, including cooperative advertising. Vendor
allowances are recognized as a reduction of
7
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
cost of sales upon the sale of merchandise or selling, general and
administrative expenses ("SG&A") when the purpose for which the vendor funds
were intended to be used has been fulfilled. Accordingly, a reduction or
increase in vendor allowances has an inverse impact on cost of sales and/or
SG&A.
Effective in 2002, the Financial Accounting Standards Board ("FASB")
Emerging Issues Task Force ("EITF") finalized Issue No. 02-16, "Accounting By a
Customer (Including a Reseller) for Cash Consideration Received from a Vendor"
("EITF 02-16"). EITF 02-16 addresses the accounting treatment for vendor
allowances and provides that cash consideration received from a vendor should be
presumed to be a reduction of the prices of the vendors' product and should
therefore be shown as a reduction in the purchase price of the merchandise.
Further, these allowances should be recognized as a reduction in cost of sales
when the related product is sold. To the extent that the cash consideration
represents a reimbursement of a specific, incremental and identifiable cost,
then those vendor allowances should be used to offset such costs.
As of July 31, 2004 and January 31, 2004, deferred vendor allowances
totaled (i) $15.9 million and $17.1 million, respectively, for owned
merchandise, which allowances are included as an offset to merchandise
inventories on the Consolidated Balance Sheets, and (ii) $8.1 million and $9.5
million, respectively, for merchandise received on consignment, which allowances
are included as deferred income on the Consolidated Balance Sheets.
HEDGING: Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities", as amended,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. Under SFAS No. 133, all derivatives, whether designated in
hedging relationships or not, are required to be recorded on the balance sheet
at fair value. SFAS No. 133 defines requirements for designation and
documentation of hedging relationships, as well as ongoing effectiveness
assessments, which must be met in order to qualify for hedge accounting. For a
derivative that does not qualify as a hedge, changes in fair value would be
recorded in earnings immediately.
We have designated our existing derivative instruments, consisting of gold
forward contracts, as cash flow hedges. For derivative instruments designated as
cash flow hedges, the effective portion of the change in the fair value of the
derivative is recorded in accumulated other comprehensive income, a separate
component of stockholders' equity, and is reclassified into cost of sales when
the offsetting effects of the hedged transaction impact earnings. Changes in the
fair value of the derivative attributable to hedge ineffectiveness are recorded
in earnings immediately. At July 31, 2004 and January 31, 2004, the fair value
of the gold forward contracts resulted in the recognition of a liability of
$139,000 and $144,000, respectively. The amount recorded in accumulated other
comprehensive loss at July 31, 2004 of $83,000, net of tax, is expected to be
reclassified into earnings through early 2005. The amount recorded in
accumulated other comprehensive loss at January 31, 2004 of $85,000, net of tax,
was reclassified into earnings in the first quarter of 2004.
We have documented all relationships between hedging instruments and hedged
items, as well as our risk management objectives and strategy for undertaking
various hedge transactions. We have also assessed, both at the hedge's inception
and on an ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in cash flows of hedged
items.
8
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
We believe that the designated hedges will be highly effective.
NET INCOME (LOSS) PER SHARE: Net loss per share has been computed in
accordance with SFAS No. 128, "Earnings per Share". Basic and diluted net loss
per share were calculated using the weighted average number of shares
outstanding during each period, with options to purchase Common Stock,
restricted stock and restricted stock units included in diluted net income per
share, using the treasury stock method, to the extent that such options,
restricted stock and restricted stock units were dilutive. As we had a net loss
for the thirteen weeks and twenty-six weeks ended July 31, 2004 and August 2,
2003, the stock options, restricted stock and restricted stock units are not
considered in the calculation of diluted net loss per share due to their
anti-dilutive effect. As a result, the weighted average number of shares
outstanding used for both the basic and diluted net loss per share calculations
was the same. Total stock options, restricted stock and restricted stock units
outstanding were 1,535,998 and 1,555,635 at July 31, 2004 and August 2, 2003,
respectively, at prices ranging from $7.05 to $24.31 per share in each period.
For the period ended July 31, 2004, 213,750 shares of restricted stock and
89,346 restricted stock units were excluded from the computation of diluted
earnings per share. For the period ended August 2, 2003, 100,000 shares of
restricted stock were excluded from the computation of diluted earnings per
share. See Note 7.
STOCK-BASED COMPENSATION: SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" amends SFAS No. 123 "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for an
entity that voluntarily changes to the fair value method of accounting for stock
options. As permitted by SFAS No. 123, we have elected to account for stock
options using the intrinsic value method. Accordingly, no compensation expense
has been recognized for our stock options. However, deferred stock-based
compensation is amortized using the straight-line method over the vesting
period. Had the fair value method of accounting been applied to our stock option
plans, which requires recognition of compensation cost ratably over the vesting
period of the stock options, net loss and net loss per share would be as
follows:
THIRTEEN WEEKS ENDED TWENTY-SIX WEEKS ENDED
------------------------------ ------------------------------
JULY 31, AUGUST 2, JULY 31, AUGUST 2,
2004 2003 2004 2003
-------------- ------------ -------------- ------------
(IN THOUSANDS)
Reported net loss ............................ $(6,141) $ (562) $(7,998) $(2,015)
Add: Stock-based compensation determined
under the fair value method, net of tax . (256) (225) (557) (450)
Deduct: Stock-based compensation expense
included in reported net loss, net of tax 175 76 397 152
------- ------- ------- -------
Pro forma net loss ........................... $(6,222) $ (711) $(8,158) $(2,313)
======= ======= ======= =======
Basic and diluted net loss per share:
Reported net loss per share .................. $ (0.71) $ (0.06) $ (0.92) $ (0.22)
======= ======= ======= =======
Pro forma net loss per share ................. $ (0.72) $ (0.08) $ (0.94) $ (0.25)
======= ======= ======= =======
COMPREHENSIVE INCOME (LOSS): SFAS No. 130, "Reporting Comprehensive Income"
requires disclosure of comprehensive income, defined as the total of net income
and all other non-owner changes in equity, which are recorded directly to the
stockholders' equity section of the consolidated balance sheet and, therefore,
bypass net income. For 2004 and 2003, the only non-owner change in equity
related
9
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
to the change in the fair value of our outstanding gold forward contracts. For
the thirteen weeks ended July 31, 2004 and August 2, 2003, the comprehensive
loss, calculated as the total of the net loss plus the change in the fair value
of our outstanding gold forward contracts, was $5.9 million and $9,000,
respectively. For the twenty-six weeks ended July 31, 2004 and August 2, 2003,
the comprehensive loss was $8.0 million and $1.5 million, respectively.
INCOME TAXES: The income tax benefit for both the 2004 and 2003 periods
reflects an effective tax rate of 39%. During the second quarter of fiscal 2004,
a benefit of approximately $0.6 million was recorded associated with the
reversal of tax accruals no longer required. Further, during the second quarter
of 2004, net current deferred tax assets decreased by approximately $10.1
million, primarily as a result of the utilization of deferred tax assets related
to the approval from the Internal Revenue Service of a favorable change of
accounting method regarding vendor allowances.
NEW ACCOUNTING PRONOUNCEMENTS: In June 2004, the FASB issued an
interpretation of FASB No. 143, "Accounting for Asset Retirement Obligations".
This interpretation clarifies the scope and timing of liability recognition for
conditional asset retirement obligations under FASB No. 143, and is effective no
later than the end of our 2005 fiscal year. We have determined that this
interpretation, and the adoption of FASB No. 143, will not have a material
impact on our consolidated financial statements.
In March 2004, the FASB published an Exposure Draft, "Shares-Based
Payment", an amendment of FASB Statements No. 123 and No. 95. Under this FASB
proposal, all forms of share-based payments to employees, including employee
stock options, would be treated as compensation and recognized in the income
statement. This proposed statement would be effective for the beginning of our
2005 fiscal year. The Company currently accounts for stock options under APB No.
25. The pro-forma impact of expensing options is disclosed above.
NOTE 3 - DESCRIPTION OF BUSINESS
We conduct business through our wholly-owned subsidiary, Finlay Jewelry. We
are a retailer of fine jewelry products and operate leased fine jewelry
departments in department stores throughout the United States. The fourth
quarter of 2003 accounted for approximately 42% of our sales and approximately
89% of our income from operations, due to the seasonality of the retail jewelry
industry. Approximately 51% of our sales in 2003 were from operations in The May
Department Stores Company ("May") and 18% in departments operated in store
groups owned by Federated Department Stores ("Federated"). Including our sales
in Marshall Fields, which May recently acquired, departments operated by May
would have accounted for 60% of our sales in 2003.
NOTE 4 - SHORT AND LONG-TERM DEBT
On January 22, 2003, Finlay Jewelry's revolving credit agreement with
General Electric Capital Corporation 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").
At July 31, 2004, $60.0 million was outstanding under this facility, at which
point the available borrowings were $143.0 million. The average amounts
outstanding under the Revolving Credit Agreement were $34.0 million and $36.6
million for the twenty-six weeks ended July 31, 2004 and August 2, 2003,
10
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - SHORT AND LONG-TERM DEBT (CONTINUED)
respectively. The maximum amount outstanding for the twenty-six weeks ended July
31, 2004 was $99.8 million, at which point the available borrowings were an
additional $113.5 million.
On May 7, 2004, we and Finlay Jewelry each commenced an offer to purchase
for cash any and all of our 9% Senior Debentures, due May 1, 2008, having an
aggregate principal amount of $75.0 million (the "Senior Debentures") and Finlay
Jewelry's 8-3/8% Senior Notes, due May 1, 2008, having an aggregate principal
amount of $150.0 million (the "Senior Notes"), respectively. In conjunction with
the tender offers, we and Finlay Jewelry each solicited consents to effect
certain proposed amendments to the indentures governing the Senior Debentures
and the Senior Notes. On May 20, 2004, we and Finlay Jewelry announced that
holders of approximately 79% and 98% of the outstanding Senior Debentures and
the outstanding Senior Notes, respectively, tendered their securities and
consented to the proposed amendments to the related indentures.
On June 3, 2004, Finlay Jewelry completed the sale of 8-3/8% Senior Notes,
due June 1, 2012, having an aggregate principal amount of $200.0 million (the
"New Senior Notes"). Interest on the New Senior Notes is payable semi-annually
on June 1 and December 1 of each year, commencing on December 1, 2004. Finlay
Jewelry used the net proceeds from the offering of the New Senior Notes,
together with drawings from its Revolving Credit Facility, to repurchase the
tendered Senior Notes and to make consent payments and to distribute $77.3
million to us to enable us to repurchase the tendered Senior Debentures and to
make consent payments. Additionally, on June 3, 2004, we and Finlay Jewelry
called for the redemption of all of the untendered Senior Debentures and Senior
Notes, respectively, and these securities were repurchased on July 2, 2004.
Finlay Jewelry incurred approximately $5.1 million in costs, including
$4.9 million associated with the sale of the New Senior Notes, which have been
deferred and are being amortized over the term of the New Senior Notes. In June
2004, we recorded pre-tax charges of approximately $9.1 million, including $6.7
million for redemption premiums paid on the Senior Debentures and the Senior
Notes, $2.1 million to write-off deferred financing costs related to the
refinancing of the Senior Debentures and the Senior Notes and $0.3 million for
other expenses. These costs are included in other expense - debt extinguishment
costs in the accompanying Consolidated Statements of Operations.
The New Senior Notes are unsecured senior obligations and rank equally
in right of payment with all of the existing and future unsubordinated
indebtedness of Finlay Jewelry and senior to any future indebtedness of Finlay
Jewelry that is expressly subordinated to the New Senior Notes. The New Senior
Notes are effectively subordinated to Finlay Jewelry's secured indebtedness,
including obligations under its Revolving Credit Agreement and its Gold
Consignment Agreement (as defined herein), to the extent of the value of the
assets securing such indebtedness, and effectively subordinated to the
indebtedness and other liabilities (including trade payables) of its
subsidiaries. Finlay Jewelry may redeem the New Senior Notes, in whole or in
part, at any time on or after June 1, 2008 at specified redemption prices, plus
accrued and unpaid interest, if any, to the date of the redemption. In addition,
before June 1, 2007, Finlay Jewelry may redeem up to 35% of the aggregate
principal amount of the New Senior Notes with the net proceeds of certain equity
offerings at 108.375% of the principal amount thereof, plus accrued interest to
the redemption date. Upon certain change of control events, each holder of the
New Senior Notes may require Finlay Jewelry to purchase all or a portion of such
holder's New Senior Notes at a purchase price equal to 101% of the principal
amount thereof, plus accrued interest to the purchase date.
11
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - SHORT AND LONG-TERM DEBT (CONTINUED)
The indenture governing the New Senior Notes contains restrictions
relating to, among other things, the payment of dividends, redemptions or
repurchases of capital stock, the incurrence of additional indebtedness, the
making of certain investments, the creation of certain liens, the sale of
certain assets, entering into transactions with affiliates, engaging in mergers
and consolidations and the transfer of all or substantially all assets.
NOTE 5 - MERCHANDISE INVENTORIES
Merchandise inventories consisted of the following:
JULY 31, JANUARY 31,
2004 2004
----------- -----------
(IN THOUSANDS)
Jewelry goods - rings, watches and other fine jewelry
(first-in, first-out ("FIFO") basis) ........... $297,629 $289,546
Less: Excess of FIFO cost over LIFO inventory value 18,396 16,598
-------- --------
$279,233 $272,948
======== ========
In accordance with EITF 02-16, merchandise inventories have been reduced
by $15.9 million and $17.1 million at July 31, 2004 and January 31, 2004,
respectively, to reflect the vendor allowances as a reduction in the cost of
merchandise. The LIFO method had the effect of increasing the loss before taxes
for the thirteen weeks ended July 31, 2004 and August 2, 2003 by $1.0 million
and $1.2 million, respectively. The LIFO method had the effect of increasing the
loss before taxes for the twenty-six weeks ended July 31, 2004 and August 2,
2003 by $1.8 million and $1.4 million, respectively. We determine our LIFO
inventory value by utilizing selected producer price indices published for
jewelry and watches by the Bureau of Labor Statistics.
Approximately $347.6 million and $364.5 million at July 31, 2004 and
January 31, 2004, respectively, of merchandise received on consignment is not
included in merchandise inventories and accounts payable-trade in the
accompanying Consolidated Balance Sheets.
Finlay Jewelry is a 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. In the event this agreement is terminated,
Finlay Jewelry would be required to return the gold or purchase the outstanding
gold at the prevailing gold rate in effect on that date. At July 31, 2004 and
January 31, 2004, amounts outstanding under the Gold Consignment Agreement
totaled 122,913 and 116,835 fine troy ounces, respectively, valued at $48.1
million and $46.7 million, respectively. For financial statement purposes, the
consigned gold is not included in merchandise inventories on the Consolidated
Balance Sheets and, therefore, no related liability has been recorded.
12
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - LEASE AGREEMENTS
We conduct substantially all of our operations as leased departments in
department stores. All of these leases, as well as rentals for office space and
equipment, are accounted for as operating leases. A substantial number of such
operating leases expire on various dates through 2008. All references herein to
leased departments refer to fine jewelry departments operated pursuant to
license agreements or other similar arrangements with host department stores.
All of the department store leases provide that, except under limited
circumstances, the title to certain of our fixed assets transfers upon
termination of the leases, and that we will receive the undepreciated value of
such fixed assets from the host store in the event such transfers occur. The
values of such fixed assets are recorded at cost at the inception of the lease
arrangement and are reflected in the accompanying Consolidated Balance Sheets.
In several cases, we are subject to limitations under our lease agreements
with host department stores which prohibit us from operating departments for
other store groups within a certain geographical radius of the host store.
The store leases provide for the payment of fees based on sales, plus, in
some instances, installment payments for fixed assets. Only minimum fees, as
represented in the table below, are guaranteed by various lease agreements.
Lease expense, included in selling, general and administrative expenses, is as
follows:
THIRTEEN WEEKS ENDED TWENTY-SIX WEEKS ENDED
---------------------- ----------------------
JULY 31, AUGUST 2, JULY 31, AUGUST 2,
2004 2003 2004 2003
-------- --------- --------- ---------
(IN THOUSANDS)
Minimum fees .. $ 850 $ 819 $ 1,700 $ 1,626
Contingent fees 30,988 29,693 61,934 58,264
------- ------- ------- -------
Total ....... $31,838 $30,512 $63,634 $59,890
======= ======= ======= =======
NOTE 7 - STOCK REPURCHASE PROGRAM AND RESTRICTED STOCK AWARDS
On December 1, 2000, we announced that our Board of Directors had approved
a stock repurchase program to acquire up to $20 million of outstanding Common
Stock. The stock repurchase program has been extended from time to time and, on
June 19, 2003, our Board of Directors approved the repurchase of an additional
$20 million of outstanding Common Stock. We may, at the discretion of
management, purchase our Common Stock, from time to time through September 30,
2004. Additionally, we currently expect the Board of Directors to approve an
extension of the stock repurchase program through September 30, 2005. 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 our cash position and
requirements going forward. The repurchase program may be modified, extended or
terminated by the Board of Directors at any time. Through 2003, we repurchased a
total of 1,815,159 shares for approximately $20,537,000. For the twenty-six
weeks ended July 31, 2004 and August 2, 2003, we repurchased 392,745 shares and
225,688 shares for $6,862,000 and $2,848,000, respectively.
13
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - STOCK REPURCHASE PROGRAM AND RESTRICTED STOCK AWARDS
(CONTINUED)
In February 2001, an executive officer of the Company was issued 100,000
shares of Common Stock, subject to restrictions ("Restricted Stock"), pursuant
to a restricted stock agreement. The Restricted Stock becomes fully vested after
four years of continuous employment with the Company and is accounted for as a
component of stockholders' equity. Compensation expense of approximately $1.2
million is being amortized over four years. Amortization for each of the
thirteen week periods ended July 31, 2004 and August 2, 2003 totaled $78,000.
Amortization for each of the twenty-six week periods ended July 31, 2004 and
August 2, 2003 totaled, approximately $152,000.
In August 2003, an executive officer of the Company was issued an
additional 50,000 shares of Restricted Stock pursuant to a restricted stock
agreement. The Restricted Stock vests fifty percent on January 31, 2005, with
the remaining fifty percent vesting on June 30, 2007, subject to the provisions
of the restricted stock agreement, and is accounted for as a component of
stockholders' equity. Compensation expense of approximately $774,000 is being
amortized over the respective vesting periods. Amortization for the thirteen
weeks and twenty-six weeks ended July 31, 2004 totaled $92,000 and $183,000,
respectively.
In October 2003, certain executives of the Company were awarded a total
of 31,250 shares of Restricted Stock, pursuant to restricted stock agreements.
The Restricted Stock becomes fully vested after four years of continuous
employment with the Company and is accounted for as a component of stockholders'
equity with respect to unamortized restricted stock compensation. However, such
shares are not considered outstanding. Compensation expense of approximately
$473,000 is being amortized over four years. Amortization for the thirteen weeks
and twenty-six weeks ended July 31, 2004 totaled $30,000 and $60,000,
respectively.
In April 2004, certain executives of the Company were awarded a total of
32,500 shares of Restricted Stock, pursuant to restricted stock agreements. The
Restricted Stock becomes fully vested after two years of continuous employment
with the Company and is accounted for as a component of stockholders' equity
with respect to unamortized restricted stock compensation. However, such shares
are not considered outstanding. Compensation expense of approximately $629,000
is being amortized over two years. Amortization for the thirteen weeks and
twenty-six weeks ended July 31, 2004 totaled $78,000.
NOTE 8 - EXECUTIVE AND DIRECTOR DEFERRED COMPENSATION AND STOCK
PURCHASE PLANS
On April 16, 2003, the Board of Directors adopted the Executive Deferred
Compensation and Stock Purchase Plan and the Director Deferred Compensation and
Stock Purchase Plan, which was approved by our stockholders on June 19, 2003
(the "RSU Plans"). Under the RSU Plans, key executives and our non-employee
directors as designated by our Compensation Committee, are eligible to acquire
restricted stock units ("RSUs"). An RSU is a unit of measurement equivalent to
one share of common stock, but with none of the attendant rights of a
stockholder of a share of common stock. Two types of RSUs are awarded under the
RSU Plans: (i) participant RSUs, where a plan participant may elect to defer, in
the case of an executive employee, a portion of his or her actual or target
bonus, and in the case of a non-employee director, his or her retainer fees and
Committee chairmanship fees, and receive RSUs in lieu
14
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - EXECUTIVE AND DIRECTOR DEFERRED COMPENSATION AND STOCK
PURCHASE PLANS (CONTINUED)
thereof and (ii) matching RSUs, where we will credit a participant's plan
account with one matching RSU for each participant RSU that a participant elects
to purchase. While participant RSUs are fully vested at all times, matching RSUs
are subject to vesting and forfeiture as set forth in the RSU Plans. At the time
of distribution under the RSU Plans, RSUs are converted into actual shares of
Common Stock. As of July 31, 2004, 89,346 restricted stock units have been
awarded under the RSU Plans. Amortization for the thirteen weeks and twenty-six
weeks ended July 31, 2004 totaled approximately $96,000 and $134,000,
respectively.
NOTE 9 - DEPARTMENT CLOSINGS
On July 30, 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 nine departments in 2003 and ten departments during the first half of
2004. In 2003, we generated approximately $20.0 million in sales from these 34
departments. Currently, May has not announced a specific timeline for when the
remaining stores will close. For the twenty-six weeks ended July 31, 2004, we
recorded charges of approximately $0.7 million, relating to the accelerated
depreciation of fixed assets, the loss on disposal of fixed assets and
severance.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
From time to time, we are involved in litigation relating to claims
arising out of our operations in the normal course of business. As of September
3, 2004, we are not a party to any legal proceedings that, individually or in
the aggregate, are reasonably expected to have a material adverse effect on our
business, results of operations, financial condition or cash flows. However, the
results of these matters cannot be predicted with certainty, and an unfavorable
resolution of one or more of these matters could have a material adverse effect
on our consolidated financial statements.
We have not provided any third-party financial guarantees as of July 31,
2004.
NOTE 11 - DISCONTINUED OPERATIONS
On August 26, 2003, we announced that Federated would not renew our lease
in the Burdines department store division due to the planned consolidation of
the Burdines and Macy's fine jewelry departments in early 2004. The termination
of the lease, effective January 31, 2004, resulted in the closure of 46 Finlay
departments in the Burdines department store division. In 2003, we generated
approximately $55.0 million in sales from the Burdines departments. The results
of operations of the Burdines departments have been segregated from those of
continuing operations, net of tax, and classified as discontinued operations for
the thirteen weeks and twenty-six weeks ended August 2, 2003.
15
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - DISCONTINUED OPERATIONS (CONTINUED)
A summary of statements of operations information relating to the
discontinued operations is as follows (in thousands):
THIRTEEN WEEKS TWENTY-SIX WEEKS
ENDED ENDED
AUGUST 2, AUGUST 2,
2003 2003
-------------- ----------------
Sales .................................... $10,543 $21,324
Income before income taxes (1) (2) ....... 737 1,738
Discontinued operations, net of tax ...... 450 1,061
- ----------
(1) Includes an allocation of $52,000 and $100,000 for the thirteen weeks and
the twenty-six weeks ended August 2, 2003, respectively, of interest expense
related to the Revolving Credit Agreement.
(2) The results of operations of the Burdines departments excludes allocations
of general and administrative expenses and interest expense related to the
Senior Notes and the Senior Debentures.
16
PART I - FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Our 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 1 of this
report. This MD&A is organized as follows:
o EXECUTIVE OVERVIEW - This section provides a general description of
our business and a brief discussion of the opportunities, challenges
and risks that we focus on in the operation of our 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 our
business.
o CRITICAL ACCOUNTING POLICIES AND ESTIMATES - This section discusses
those accounting policies that both are considered important to our
financial condition and results of operations, and require us to
exercise subjective or complex judgments in their application. In
addition, all of our significant accounting policies, including
critical accounting policies, are summarized in Note 2 to the
consolidated financial statements included in our Form 10-K.
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 our historical results or current
expectations or projections.
The results of operations for the thirteen weeks and twenty-six weeks
ended August 2, 2003 reflect the Burdines departments as a discontinued
operation.
EXECUTIVE OVERVIEW
OUR BUSINESS
We are one of the leading retailers of fine jewelry in the United States
and operate fine jewelry departments in major department stores for retailers
such as May and Federated. We sell a broad selection of moderately priced
jewelry, with an average sales price of approximately $191 per item. As of July
31, 2004, we operated 967 locations in 17 host store groups, in 46 states and
the District of Columbia.
Our primary focus is to offer high quality, desirable and competitively
priced products, a breadth of merchandise assortments and to provide superior
customer service. Our ability to quickly identify emerging trends and maintain
strong relationships with vendors has enabled us to present better assortments
in our showcases. We believe that we are an important contributor to each of our
host store groups and we continue to seek opportunities to penetrate the
department store segment. By outsourcing their fine jewelry departments to us,
host store groups gain our expertise in merchandising, selling and marketing
jewelry and customer service. Additionally, by avoiding high working capital
investments
17
typically required of the traditional retail jewelry business, host stores
improve their return on investment and increase their profitability. As a
lessee, we benefit from the host stores' reputation, customer traffic, credit
services and established customer base. We also avoid the substantial capital
investment in fixed assets typical of a stand-alone retail format. These factors
have generally led our new departments to achieve profitability within the first
twelve months of operation.
We measure ourselves against key financial measures that we believe provide
a well-balanced perspective regarding our 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 period, is an
indicator of the increased returns generated for our 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
our host store groups as well as other jewelry retailers;
o Total sales growth (current period total sales minus prior period
total sales divided by prior period total sales equals percentage
change) which indicates, among other things, the success of our
selection of new store locations and the effectiveness of our
merchandising strategies; and
o Operating margin rate (income from operations divided by net sales)
which is an indicator of our success in leveraging our fixed costs and
managing our variable costs.
SECOND QUARTER HIGHLIGHTS
During the second quarter of 2004, we continued to successfully execute our
marketing and merchandising strategy, as evidenced by our 3.2% growth in
comparable department sales. Total sales were $188.6 million for the thirteen
weeks ended July 31, 2004 compared to $182.2 million for the thirteen weeks
ended August 2, 2003, an increase of 3.5%. Gross margin increased by $2.7
million compared to 2003, and as a percentage of sales, gross margin decreased
by 0.3% from 50.9% to 50.6%. Although SG&A increased $2.9 million, as a
percentage of sales, SG&A remained flat at 46.3%. Although borrowings under the
Revolving Credit Agreement increased by $26.2 million at July 31, 2004 as
compared to August 2, 2003, primarily as a result of the refinancing of the
Senior Debentures and the Senior Notes, the average outstanding balance under
the Revolving Credit Agreement decreased to $34.0 million as compared to $36.6
million in the prior year. Maximum outstanding borrowings during the twenty-six
weeks ended July 31, 2004 peaked at $99.8 million, at which point the available
borrowings under the Revolving Credit Agreement were an additional $113.5
million.
During the second quarter of 2004, we and Finlay Jewelry completed the
redemption of the outstanding 9% Senior Debentures having an aggregate principal
amount of $75.0 million and the 8 3/8% Senior Notes having an aggregate
principal amount of $150.0 million. Additionally, in June 2004, Finlay Jewelry
completed the sale of the 8 3/8% New Senior Notes having an aggregate principal
amount of $200.0 million. The tender offers, New Senior Notes offering and
redemptions of the outstanding Senior Debentures and Senior Notes were all
undertaken to simplify our capital structure by eliminating debt at the parent
company level, as well as decreasing total long-term debt, decreasing our
overall interest rate and extending our debt maturities.
18
OUTLOOK
We continue to seek growth opportunities and plan to continue to pursue the
following key initiatives:
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 our stock repurchase program.
We believe that current trends in jewelry retailing provide a significant
opportunity for our growth. Consumers spent approximately $54.0 billion on
jewelry (including both fine jewelry and costume jewelry) in the United States
in calendar year 2003, an increase of approximately $19.9 billion over 1993,
according to the United States Department of Commerce, representing a compound
annual growth rate of 4.7%. In the department store sector in which we operate,
consumers spent an estimated $4.0 billion on fine jewelry in calendar year 2002.
Our management believes that demographic factors such as the maturing 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. Our management also believes that jewelry consumers today
increasingly perceive fine jewelry as a fashion accessory, resulting in
purchases which augment our gift and special occasion sales.
OPPORTUNITIES, RISKS AND UNCERTAINTIES
We achieved sustained growth during 2003 and the first half of 2004,
however, we 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 our 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, we recorded a non-cash charge of
$13.8 million in 2003 for the write-down of goodwill resulting from the closure
of the Burdines departments.
19
Additionally, during 2003, May announced its intention to close certain of
its smaller, less profitable stores, including 32 Lord & Taylor stores, as well
as two stores in its Famous-Barr division, resulting in the closure of nine
departments in 2003 and ten departments during the first half of 2004. In 2003,
we generated approximately $20 million in sales from these 34 departments.
During 2003, approximately 51% and 18% of our sales were generated by
departments operated in store groups owned by May and Federated, respectively.
Including our sales in Marshall Fields, which May recently acquired, departments
operated by May would have accounted for 60% of our sales in 2003. We have
operated departments with May since 1948 and with Federated since 1983. We
believe that our 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 our business and financial
condition. Additionally, the department store industry may experience
significant consolidations in the future. Although we have, in the past,
generally benefited from host store consolidations, there is no assurance that
our 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 our growth. We consider it a high priority to identify new
businesses that offer growth, financial viability and manageability and will
have a positive impact on shareholder value.
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:
STATEMENTS OF OPERATIONS DATA
THIRTEEN WEEKS ENDED TWENTY-SIX WEEKS ENDED
---------------------------- -----------------------------
JULY 31, AUGUST 2, JULY 31, AUGUST 2,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Sales...................................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales.............................................. 49.4 49.1 49.3 48.7
----------- ----------- ----------- -----------
Gross margin........................................... 50.6 50.9 50.7 51.3
Selling, general and administrative expenses............... 46.3 46.3 46.7 47.1
Depreciation and amortization.............................. 2.3 2.3 2.3 2.3
----------- ----------- ----------- -----------
Income from operations................................. 2.0 2.3 1.7 1.9
Interest expense, net...................................... 3.1 3.2 3.0 3.3
Other expense - debt extinguishment costs.................. 4.8 -- 2.4 --
----------- ----------- ----------- -----------
Loss from continuing operations before
income taxes......................................... (5.9) (0.9) (3.7) (1.4)
Benefit for income taxes................................... (2.6) (0.4) (1.6) (0.5)
----------- ----------- ----------- -----------
Loss from continuing operations........................ (3.3) (0.5) (2.1) (0.9)
Discontinued operations, net of tax........................ - 0.2 - 0.3
----------- ----------- ----------- -----------
Net loss............................................... (3.3) % (0.3)% (2.1) % (0.6)%
=========== =========== =========== ===========
THIRTEEN WEEKS ENDED JULY 31, 2004 COMPARED WITH THIRTEEN WEEKS ENDED
AUGUST 2, 2003
SALES. Sales for the thirteen weeks ended July 31, 2004 increased $6.4
million, or 3.5%, over the comparable period in 2003. Comparable department
sales (departments open for the same months during the comparable periods)
increased 3.2%. We attribute the increase in sales primarily to our
20
merchandising and marketing strategy, which includes the following initiatives:
(i) emphasizing our "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 our departments as "destination locations" for fine jewelry.
During the thirteen weeks ended July 31, 2004, we opened four departments,
including three departments in Dillard's and closed seven departments. The
openings and closings were all within existing store groups.
GROSS MARGIN. Gross margin for the period increased by $2.7 million in 2004
compared to 2003, and, as percentage of sales, gross margin decreased by 0.3%.
The components of this 0.3% net decrease in gross margin are as follows:
COMPONENT % REASON
------------------------------ -------- -------------------------------
Merchandise cost of sales..... (0.7) Increase in merchandise cost of
sales is primarily due to our
continued efforts to increase
market penetration and market
share through our pricing
strategy, as well as the mix of
sales with increased sales in
the diamond, designer and
clearance categories, which
have lower margins than other
categories.
LIFO ......................... 0.2 Decrease in the LIFO provision
from $1.2 million to $1.0
million.
Shortage ..................... 0.2 The 2004 physical inventory
----- results (actual shortage vs.
accrual) were more favorable as
compared to the 2003 results.
Total ........... (0.3)%
====
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 $2.9 million, or 3.5%. As a
percentage of sales, SG&A remained flat at 46.3%.
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 $0.2 million, associated with the Lord & Taylor
store closings, were recorded in the period.
INTEREST EXPENSE, NET. Interest expense decreased by $0.1 million primarily
due to a decrease in average borrowings ($272.7 million for the period in 2004
compared to $275.2 million for the comparable period in 2003). The weighted
average interest rate was approximately 7.4% for the 2004 period compared to
7.6% for the comparable period in 2003.
OTHER EXPENSE - DEBT EXTINGUISHMENT COSTS. Other expense - debt
extinguishment costs includes $6.7 million for redemption premiums paid on the
Senior Debentures and the Senior Notes, $2.1 million to write-off deferred
financing costs related to the refinancing of the Senior Debentures and the
Senior Notes and $0.3 million for other expenses.
BENEFIT FOR INCOME TAXES. The income tax benefit for both the 2004 and
2003 periods reflects effective tax rates of 39%. Additionally, the 2004 period
includes a benefit of approximately $0.6 million associated with the reversal of
tax accruals no longer required.
21
DISCONTINUED OPERATIONS. Discontinued operations includes the results of
operations of the Burdines departments. Income from discontinued operations, net
of tax, for the 2003 period was $0.5 million.
NET LOSS. Net loss of $6.1 million for the 2004 period represents an
increase of $5.5 million as compared to the net loss of $0.6 million in the
prior period as a result of the factors discussed above.
TWENTY-SIX WEEKS ENDED JULY 31, 2004 COMPARED WITH TWENTY-SIX WEEKS ENDED
AUGUST 2, 2003
SALES. Sales for the twenty-six weeks ended July 31, 2004 increased $18.6
million, or 5.2%, over the comparable period in 2003. Comparable department
sales increased 5.0%.
During the twenty-six weeks ended July 31, 2004, we opened 13 departments
and closed 18 departments. The openings and closings were all within existing
store groups. The openings included eight departments in Dillard's and the
closings included nine departments in Lord & Taylor and one in Famous Barr as a
result of May's decision to close certain of its smaller, less profitable
stores.
GROSS MARGIN. Gross margin for the period increased by $7.1 million in 2004
compared to 2003, and, as percentage of sales, gross margin decreased by 0.6%.
The components of this 0.6% net decrease in gross margin are as follows:
COMPONENT % REASON
----------------------------- ------ -------------------------------
Merchandise cost of sales.... (0.5) Increase in merchandise cost of
sales is primarily due to our
continued efforts to increase
market penetration and market
share through our pricing
strategy, as well as the mix of
sales with increased sales in
the diamond, designer, and
clearance categories, which
have lower gross margins than
other categories.
LIFO ........................ (0.1) Increase in the LIFO provision
from $1.4 million to $1.8
million.
----
Total .......... (0.6)%
====
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 $6.9 million, or 4.1%. As a
percentage of sales, SG&A decreased to 46.7% from 47.1%. The components of this
0.4% net decrease in SG&A are as follows:
COMPONENT % REASON
-------------------------------- ------ -------------------------------
Net advertising expenditures.... 0.4 Decrease in net advertising
expenditures is due to lower
gross advertising expenditures
as a percentage of sales.
Lease fees .................... (0.2) Increase in lease fees is due
to a change in the mix of host
store group sales.
Other expenses.................. 0.2 Decrease in other expenses is
due primarily to the favorable
leveraging of these expenses.
---
Total ........... 0.4%
===
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased $0.4
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 $0.3 million, associated with the Lord & Taylor
store closings, were recorded in the period.
22
INTEREST EXPENSE, NET. Interest expense decreased by $0.2 million primarily
due to a decrease in average borrowings ($253.9 million for the period in 2004
compared to $261.6 million for the comparable period in 2003). The weighted
average interest rate was approximately 7.9% for the 2004 and the 2003 periods.
OTHER EXPENSE - DEBT EXTINGUISHMENT COSTS. Other expense - debt
extinguishment costs includes $6.7 million for redemption premiums paid on the
Senior Debentures and the Senior Notes, $2.1 million to write-off deferred
financing costs related to the refinancing of the Senior Debentures and the
Senior Notes and $0.3 million for other expenses.
BENEFIT FOR INCOME TAXES. The income tax benefit for both the 2004 and
2003 periods reflects effective tax rates of 39%. Additionally, the 2004 period
includes a benefit of approximately $0.6 million associated with the reversal of
tax accruals no longer required
DISCONTINUED OPERATIONS. Discontinued operations includes the results of
operations of the Burdines departments. Income from discontinued operations, net
of tax, for the 2003 period was $1.1 million.
NET LOSS. Net loss of $8.0 million for the 2004 period represents an
increase of $6.0 million as compared to the net loss of $2.0 million in the
prior period as a result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Information about our financial position as of July 31, 2004 and January
31, 2004 is presented in the following table:
JULY 31, JANUARY 31,
2004 2004
-------- -----------
(DOLLARS IN THOUSANDS)
Cash and cash equivalents......... $1,802 $91,302
Working capital................... 205,650 238,333
Long-term debt.................... 200,000 225,000
Stockholders' equity.............. 142,547 152,896
Our primary capital requirements are for funding working capital for new
departments and for 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, capital
expenditures totaled $12.9 million and for 2004 are estimated to be
approximately $12 to $14 million. Although capital expenditures are limited by
the terms of the Revolving Credit Agreement, to date, this limitation has not
precluded us from satisfying our capital expenditure requirements.
We currently expect to fund capital expenditure requirements as well as
liquidity needs from a combination of cash, internally generated funds and
borrowings under our Revolving Credit Agreement. We believe that our internally
generated liquidity through cash flows from operations, together with access to
external capital resources, will be sufficient to satisfy existing commitments
and plans and will provide adequate financing flexibility.
23
Cash flows provided from (used in) operating, investing and financing
activities for the twenty-six weeks ended July 31, 2004 and August 2, 2003 were
as follows:
TWENTY-SIX WEEKS ENDED
---------------------------
JULY 31, AUGUST 2,
2004 2003
--------- ----------
(DOLLARS IN THOUSANDS)
Operating activities..................... $(115,044) $(101,373)
Investing activities..................... (5,635) (5,007)
Financing activities..................... 31,179 39,416
--------- ---------
Net decrease in cash and cash
equivalents ................. $ (89,500) $ (66,964)
========= =========
Our current priorities for the use of cash or borrowings, as a result of
borrowings available under the Revolving Credit Agreement, are:
o Investment in inventory and for working capital;
o Capital expenditures for new departments, expansions and remodeling of
existing departments;
o Investments in technology;
o Strategic acquisitions; and
o Stock repurchases under our stock repurchase program.
OPERATING ACTIVITIES
The primary source of our 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 used in operating activities were $115.0 million and
$101.4 million for the twenty-six weeks ended July 31, 2004 and August 2, 2003,
respectively.
Our operations substantially preclude customer receivables as our 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
us approximately three weeks after the end of such month. However, we cannot
ensure the collection of sales proceeds from our host stores. Additionally, on
average, approximately 50% of our merchandise has been carried on consignment.
Our working capital balance was $205.7 million at July 31, 2004, a decrease of
$32.7 million from January 31, 2004, resulting primarily from the impact of the
interim net loss (exclusive of depreciation and amortization), capital
expenditures, the purchase of treasury stock and additional borrowings under the
Revolving Credit Agreement related to the refinancing of the Senior Debentures
and the Senior Notes.
The seasonality of our 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, we experience seasonal cash needs as
inventory levels peak. Additionally, substantially all of our lease agreements
provide for accelerated payments during the months of November and December,
which require the host store groups to remit to us 75% of the estimated months'
sales prior to or shortly following the end of that month. These proceeds result
in a significant increase in our cash, which is used to reduce our borrowings
under the Revolving Credit Agreement. Inventory levels increased by $14.4
million, or 5.4%, as compared to August 2, 2003, as a result of further
investments in the diamond and designer categories. Although the increased
inventory levels in 2004 has increased our outstanding borrowings under
24
the Revolving Credit Agreement, our average amounts outstanding are slightly
lower than for the comparable period in 2003.
INVESTING ACTIVITIES
Investing cash outflows include payments for capital expenditures,
including property and equipment. Net cash used in investing activities was $5.6
million and $5.0 million for the twenty-six weeks ended July 31, 2004 and August
2, 2003, respectively. Capital expenditures during each period related primarily
to expenditures for new department openings and renovations.
FINANCING ACTIVITIES
Proceeds from, and principal payments on, the Revolving Credit Facility and
stock repurchases have been our primary financing activities. Additionally,
during the second quarter of 2004, we refinanced our long-term debt. Net cash
provided by financing activities was $31.2 million for the twenty-six weeks
ended July 31, 2004, consisting principally of proceeds from, and principal
payments on, the Revolving Credit Facility, proceeds from the issuance of the
New Senior Notes by Finlay Jewelry and funds received from stock option
exercises, offset by the purchase and redemption of the outstanding Senior
Debentures and the Senior Notes and the repurchase of 392,745 shares of Common
Stock for approximately $6.9 million under our stock repurchase program. Net
cash provided by financing activities was $39.4 million for the twenty-six weeks
ended August 2, 2003.
In January 2003, we entered into the Revolving Credit Agreement, which
expires in January 2008. The Revolving Credit Agreement provides us 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 our 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 our financial performance. The weighted average interest
rate was 3.6% and 3.7% for the twenty-six weeks ended July 31, 2004 and August
2, 2003, respectively.
In each year, we are 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 were $60.0 million at July 31, 2004, compared to
a zero balance at January 31, 2004 and $33.8 million at August 2, 2003. The
average amounts outstanding under the Revolving Credit Agreement were $34.0
million and $36.6 million for the twenty-six weeks ended July 31, 2004 and
August 2, 2003, respectively. The maximum amount outstanding for the twenty-six
weeks ended July 31, 2004 was $99.8 million, at which point the available
borrowings were an additional $113.5 million.
On May 7, 2004, we and Finlay Jewelry each commenced an offer to purchase
for cash any and all of our Senior Debentures and Finlay Jewelry's Senior Notes,
respectively. In conjunction with the tender offers, we and Finlay Jewelry each
solicited consents to effect certain proposed amendments to the indentures
governing the Senior Debentures and the Senior Notes. On May 20, 2004, we and
Finlay Jewelry announced that holders of approximately 79% and 98% of the
outstanding Senior Debentures and the outstanding Senior Notes, respectively,
tendered their securities and consented to the proposed amendments to the
related indentures.
25
On June 3, 2004, Finlay Jewelry completed the sale of the New Senior Notes.
Interest on the New Senior Notes is payable semi-annually on June 1 and December
1 of each year, commencing on December 1, 2004. Finlay Jewelry used the net
proceeds from the offering of the New Senior Notes, together with drawings from
its Revolving Credit Facility, to repurchase the tendered Senior Notes and to
make consent payments and to distribute $77.3 million to us to enable us to
repurchase the tendered Senior Debentures and to make consent payments.
Additionally, on June 3, 2004, we and Finlay Jewelry called for the redemption
of all of the untendered Senior Debentures and Senior Notes, respectively, and
these securities were repurchased on July 2, 2004.
The tender offers, New Senior Notes offering, and redemptions of the
outstanding Senior Debentures and Senior Notes were all undertaken to simplify
our capital structure by eliminating debt at the parent company level, as well
as decreasing total long-term debt, decreasing our overall interest rate and
extending our debt maturities. As a result of the completion of the redemption
of the Senior Debentures, Finlay Jewelry is no longer required to provide the
funds necessary to pay the higher debt service costs associated with the Senior
Debentures.
Finlay Jewelry incurred approximately $5.1 million in costs, including $4.9
million associated with the sale of the New Senior Notes, which have been
deferred and are being amortized over the term of the New Senior Notes. In June
2004, we recorded pre-tax charges of approximately $9.1 million, including $6.7
million for redemption premiums paid on the Senior Debentures and the Senior
Notes, $2.1 million to write-off deferred financing costs related to the
refinancing of the Senior Debentures and the Senior Notes and $0.3 million for
other expenses. These costs are included in other expense - debt extinguishment
costs in the accompanying Consolidated Statements of Operations.
In the past, a significant amount of our operating cash flow has been used
to pay interest 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. Although the Senior
Debentures and the Senior Notes are no longer outstanding as a result of the
refinancing, a significant amount of our operating cash flow will still be
required to pay interest directly, with respect to the New Senior Notes and the
amounts due under the Revolving Credit Agreement, including payments required
under the Balance Reduction Requirement. As of July 31, 2004, our outstanding
borrowings were $260.0 million, which included a $200.0 million balance under
the New Senior Notes and a $60.0 million balance under the Revolving Credit
Agreement.
Our agreements covering the Revolving Credit Agreement and the New Senior
Notes each require that we comply with certain restrictive and financial
covenants. In addition, Finlay Jewelry is a party to the Gold Consignment
Agreement, which also contains certain covenants. As of and for the twenty-six
weeks ended July 31, 2004, we are in compliance with all of our covenants. We
expect to be in compliance with all of our covenants through 2004. Because
compliance is based, in part, on our management's estimates and actual results
can differ from those estimates, there can be no assurance that we will be in
compliance with the covenants in the future or that the lenders will waive or
amend any of the covenants should we be in violation thereof. We believe the
assumptions used are appropriate.
The Revolving Credit Agreement contains customary covenants, including
limitations on, or relating to, capital expenditures, liens, indebtedness,
investments, mergers, acquisitions, affiliate transactions, management
compensation and the payment of dividends and other restricted payments. The
Revolving Credit Agreement also contains various financial covenants, including
minimum earnings and fixed charge coverage ratio requirements and certain
maximum debt limitations.
The indenture related to the New Senior Notes contains restrictions
relating to, among other things, the payment of dividends, redemptions or
repurchases of capital stock, the incurrence of additional
26
indebtedness, the making of certain investments, the creation of certain liens,
the sale of certain assets, entering into transactions with affiliates, engaging
in mergers and consolidations and the transfer of all or substantially all
assets.
We believe that, based upon current operations, anticipated growth and
continued availability under the Revolving Credit Agreement, Finlay Jewelry
will, for the foreseeable future, be able to meet its debt service and
anticipated working capital obligations and to make distributions sufficient to
permit us to pay certain expenses as they come due. No assurances, however, can
be given that Finlay Jewelry's current level of operating results will continue
or improve or that Finlay Jewelry's income from operations will continue to be
sufficient to permit Finlay Jewelry to meet its debt service and other
obligations. Currently, Finlay Jewelry's principal financing arrangements
restrict the amount of annual distributions from Finlay Jewelry to us. Other
dividends and distributions, including those required to fund stock repurchases,
are subject to Finlay's satisfaction of certain restrictive covenants. The
amounts required to satisfy the aggregate of Finlay Jewelry's interest expense
totaled $8.8 million and $8.0 million for the twenty-six weeks ended July 31,
2004 and August 2, 2003, respectively.
Our long-term needs for external financing will depend on our rate of
growth, the level of internally generated funds and the ability to continue
obtaining substantial amounts of merchandise on advantageous terms, including
consignment arrangements with our vendors. As of July 31, 2004, $347.6 million
of consignment merchandise from approximately 300 vendors was on hand as
compared to $352.1 million at August 2, 2003. For 2003, we had an average
balance of consignment merchandise of $364.7 million.
The following tables summarize our contractual and commercial obligations
which may have an impact on future liquidity and the availability of capital
resources, as of July 31, 2004 (dollars in thousands):
PAYMENTS DUE BY PERIOD
--------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1 YEAR 1 - 3 YEARS 3 - 5 YEARS MORE THAN 5 YEARS
- ------------------------------------- ----- ---------------- ----------- ----------- -----------------
Long-Term Debt Obligations:
New Senior Notes (due 2012) (1) ....... $200,000 $ -- $ -- $ -- $200,000
Interest payments on New Senior Notes ...... 134,000 16,750 33,500 33,500 50,250
Operating lease obligations (2) ............ 9,070 2,028 3,847 3,195 --
Revolving Credit
Agreement (due 2008) (3) ................ 59,968 59,968 -- -- --
Gold Consignment
Agreement (expires 2005) ................ 48,108 48,108 -- -- --
Letters of credit .......................... 11,690 11,440 -- 250 --
-------- -------- ------- ------- --------
Total ..................................... $462,836 $138,294 $37,347 $36,945 $250,250
======== ======== ======= ======= ========
- ----------
(1) On June 3, 2004, Finlay Jewelry issued $200.0 million of New Senior Notes
due 2012. Refer to Note 4 of Notes to the Consolidated Financial
Statements.
(2) Represents future minimum payments under noncancellable operating leases
as of January 31, 2004.
(3) The outstanding balance on the Revolving Credit Agreement at September 3,
2004 was $80.7 million.
We enter into arrangements with vendors to purchase merchandise up to
three months in advance of expected delivery. These purchase orders do not
contain any significant termination payments or other penalties if cancelled.
OFF-BALANCE SHEET ARRANGEMENTS
Finlay Jewelry's Gold Consignment Agreement enables Finlay Jewelry to
receive consignment merchandise by providing gold, or otherwise making payment,
to certain vendors. While the merchandise
27
involved remains consigned, title to the gold content of the merchandise
transfers from the vendors to the gold consignor. The Gold Consignment Agreement
matures on July 31, 2005 and permits Finlay Jewelry to consign up to the lesser
of (i) 165,000 fine troy ounces or (ii) $50.0 million worth of gold, subject to
a formula as prescribed by the Gold Consignment Agreement. Finlay Jewelry
believes its relationship with the gold consignor is good and expects to be in a
position to extend the Gold Consignment Agreement upon its expiration. At July
31, 2004, amounts outstanding under the Gold Consignment Agreement totaled
122,913 fine troy ounces, valued at $48.1 million. The average amount
outstanding under the Gold Consignment Agreement was $48.0 million in 2003. In
the event this agreement is terminated, Finlay Jewelry would be required to
return the gold or purchase the outstanding gold at the prevailing gold rate in
effect on that date. For financial statement purposes, the consigned gold is not
included in merchandise inventories on the Consolidated Balance Sheets and,
therefore, no related liability has been recorded.
The Gold Consignment Agreement requires Finlay Jewelry to comply with
certain covenants, including restrictions on the incurrence of certain
indebtedness, the creation of liens, engaging in transactions with affiliates
and limitations on the payment of dividends. In addition, the Gold Consignment
Agreement also contains various financial covenants, including minimum earnings
and fixed charge coverage ratio requirements and certain maximum debt
limitations. At July 31, 2004, Finlay Jewelry was in compliance with all of its
covenants under the Gold Consignment Agreement.
We have not created, and are not party to, any off-balance sheet entities
for the purpose of raising capital, incurring debt or operating our business. We
do not have any arrangements or relationships with entities that are not
consolidated into the financial statements that are reasonably likely to
materially affect our liquidity or the availability of capital resources.
OTHER ACTIVITIES AFFECTING LIQUIDITY
We have an employment agreement with one senior executive which provides
for a minimum salary level as well as incentive compensation based on meeting
specific financial goals. This agreement expires on January 31, 2005 and has a
remaining aggregate minimum value of $0.5 million as of July 31, 2004.
From time to time, we enter into forward contracts based upon the
anticipated sales of gold product in order to hedge against the risk arising
from our payment arrangements. At July 31, 2004, we had several open positions
in gold forward contracts totaling 54,500 fine troy ounces, to purchase gold for
$21.7 million. There can be no assurance that these hedging techniques will be
successful or that hedging transactions will not adversely affect our results of
operations or financial position.
In January 2000, Sonab, our European leased jewelry department subsidiary,
sold the majority of its assets for approximately $9.9 million. We recorded a
pre-tax charge in the fourth quarter of 1999 of $28.6 million, or $1.62 per
share on a diluted basis after-tax. As of July 31, 2004, our exit plan has been
completed with the exception of certain employee litigation and other legal
matters. To date, we have charged a total of $26.4 million against our revised
estimate of $27.2 million. We do not believe future operating results or
liquidity will be materially impacted by any remaining payments or litigation
and legal matters mentioned above.
SEASONALITY
Our business is highly seasonal, with a significant portion of our sales
and income from operations generated during the fourth quarter of each year,
which includes the year-end holiday season. The fourth quarter of 2003 accounted
for approximately 42% of our sales and approximately 89% of our income
28
from operations. We have typically experienced net losses in the first three
quarters of our fiscal year. During these periods, working capital requirements
have been funded by borrowings under the Revolving Credit Agreement.
Accordingly, the results for any of the first three quarters of any given fiscal
year, taken individually or in the aggregate, are not indicative of annual
results.
INFLATION
The effect of inflation on our results of operations has not been material
in the periods discussed.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our Consolidated Financial Statements have been prepared in accordance
with accounting principles generally accepted in the United States of America.
These generally accepted accounting principles require our management to make
estimates and assumptions that affect certain financial statement accounts
reported and disclosed at the date of the financial statements. Actual results
may differ from those estimates.
Certain of our significant accounting policies are described in Note 2 to
the consolidated financial statements included in our Form 10-K. We believe that
the following discussion addresses the critical accounting policies which are
most important to the portrayal of our financial condition and results of
operations and require our management's most difficult, subjective or complex
judgments. We are not aware of any likely events or circumstances which would
result in different amounts being reported that would materially affect our
financial condition or results of operations.
MERCHANDISE INVENTORIES
We value our inventories at the lower of cost or market. The cost is
determined by the last-in, first-out method utilizing selected producer price
indices published for jewelry and watches by the Bureau of Labor Statistics.
Factors related to inventories, such as future consumer demand and the economy's
impact on consumer discretionary spending, inventory aging, ability to return
merchandise to vendors, merchandise condition and anticipated markdowns, are
analyzed to determine estimated net realizable values. An adjustment is recorded
to reduce the LIFO cost of inventories, if required. Any significant
unanticipated changes in the factors above could have a significant impact on
the value of the inventories and our reported operating results.
Shrinkage is estimated for the period from the last inventory date to the
end of the fiscal year on a store by store basis. The shrinkage rate from the
most recent physical inventory, in combination with historical experience, is
the basis for estimating shrinkage.
VENDOR ALLOWANCES
We receive allowances from our vendors through a variety of programs and
arrangements, including cooperative advertising. Vendor allowances are
recognized as a reduction of cost of sales upon the sale of merchandise or SG&A
when the purpose for which the vendor funds were intended to be used has been
fulfilled. Accordingly, a reduction or increase in vendor allowances has an
inverse impact on cost of sales and/or SG&A.
FINITE-LIVED ASSETS
Finite-lived assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of the assets may not
be recoverable. If the undiscounted future cash
29
flows from the finite-lived assets are less than the carrying value, we
recognize a loss equal to the difference between the carrying value and the fair
value of the assets. We determine the fair value of the underlying assets based
upon the discounted future cash flows of the assets. Various factors, including
future sales growth and profit margins, are included in this analysis. To the
extent these future projections or our strategies change, the conclusion
regarding impairment may differ from the current estimates.
GOODWILL
We evaluate goodwill for impairment annually or whenever events and changes
in circumstances suggest that the carrying amount may not be recoverable from
our estimated future cash flows. To the extent these future cash flows or our
strategies change, the conclusion regarding impairment may differ from current
estimates.
REVENUE RECOGNITION
We recognize revenue upon the sale of merchandise, either owned or
consigned, to our customers, net of anticipated returns. The provision for sales
returns is based on our historical return rate.
SELF-INSURANCE RESERVES
We are self-insured for medical and workers' compensation claims up to
certain maximum liability amounts. Although the amounts accrued are actuarially
determined based on analysis of historical trends of losses, settlements,
litigation costs and other factors, the amounts that we will ultimately disburse
could differ materially from the accrued amounts.
INCOME TAXES
We are subject to income taxes in many jurisdictions and must first
determine which revenues and expenses should be included in each taxing
jurisdiction. This process involves the estimation of our actual current tax
exposure, together with the assessment of temporary differences resulting from
differing treatment of income or expense items for tax and accounting purposes.
We establish tax reserves in our consolidated financial statements based on our
estimation of current tax exposures. If we prevail in tax matters for which
reserves have been established or if we are required to settle matters in excess
of established reserves, the effective tax rate for a particular period could be
materially affected.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2004, the FASB issued an interpretation of FASB No. 143,
"Accounting for Asset Retirement Obligations". This interpretation clarifies the
scope and timing of liability recognition for conditional asset retirement
obligations under FASB No. 143, and is effective no later than the end of our
2005 fiscal year. We have determined that this interpretation, and the adoption
of FASB No. 143, will not have a material impact on our consolidated financial
statements.
In March 2004, the FASB published an Exposure Draft, "Shares-Based
Payment", an amendment of FASB Statements No. 123 and No. 95. Under this FASB
proposal, all forms of share-based payments to employees, including employee
stock option, would be treated as compensation and recognized in the income
statement. This proposed statement would be effective for the beginning of our
2005 fiscal year. The Company currently accounts for stock options under APB No.
25. The pro-forma impact of expensing options is disclosed in the accompanying
Notes to the Consolidated Financial Statements.
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 (the "Securities Act") and Section 21E
of the Securities Exchange Act of 1934. All statements other than statements of
historical information provided herein are forward-looking statements and may
contain information about financial results, economic conditions, trends and
known uncertainties. The forward-looking statements contained herein are subject
to certain risks and uncertainties that could cause actual results, performances
or achievements to differ materially from those reflected in, or implied by, the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed under "Management's Discussion and
Analysis of Financial Condition and Results of Operations". Important factors
that could cause actual results to differ materially include, but are not
limited to:
o our dependence on or loss of certain host store relationships,
particularly with respect to May and Federated, due to the
concentration of sales generated by such host stores;
o the impact of significant store closures by our host store
groups;
o the seasonality of the retail jewelry business;
o the impact of changes in the popularity of malls and our host
stores and mall traffic levels;
o our ability to continue to obtain substantial amounts of
merchandise on consignment;
o Finlay Jewelry's continuation of its Gold Consignment Agreement;
o the impact of fluctuations in gold and diamond prices;
o attacks or threats of attacks by terrorists or war which may
negatively impact the economy and/or the financial markets and
reduce discretionary spending;
o trends in the general economy in the United States;
o low or negative growth in the economy or in the financial markets
which reduce discretionary spending on goods perceived to be
luxury items;
o competition in the retail jewelry business and fluctuations in
our quarterly results;
o our ability to collect net sales proceeds from our host stores;
o the impact of any host store bankruptcy;
o the availability to us of alternate sources of merchandise supply
in the case of an abrupt loss of any significant supplier;
o our ability to identify and rapidly respond to fashion trends;
o our ability to increase comparable department sales, expand our
business or increase the number of departments we operate;
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o our ability to identify, finance and integrate any future
acquisitions into our existing business;
o our dependence on key officers;
o our compliance with applicable contractual covenants;
o the impact of future claims and legal actions arising in the
ordinary course of business;
o the impact of recent accounting developments, including the
impact of proposed accounting standards to require companies to
expense stock options;
o our high degree of leverage and the availability to us of
financing and credit on favorable terms; and
o changes in regulatory requirements which are applicable to our
business.
Readers are cautioned not to unduly rely on these forward-looking
statements, which reflect our management's analysis, judgment, belief or
expectation only as of the date hereof. We undertake no obligation to publicly
revise these forward-looking statements to reflect events or circumstances that
arise after the date hereof or to reflect the occurrence of unanticipated
events. In addition to the disclosure contained herein, readers should carefully
review any disclosure of risks and uncertainties contained in other documents we
file or have filed from time to time with the Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk through the interest rate on our borrowings
under the Revolving Credit Agreement, which has a variable interest rate. Based
on the average amounts outstanding under the Revolving Credit Agreement for
2003, a 100 basis point change in interest rates would have resulted in an
increase in interest expense of approximately $427,000. In seeking to minimize
the risks from interest rate fluctuations, we manage exposures through our
regular operating and financing activities. In addition, the majority of our
borrowings are under fixed rate arrangements, as described in Note 4 of Notes to
Consolidated Financial Statements.
COMMODITY RISK
We enter into forward contracts for the purchase of the majority of our
gold in order to hedge the risk of gold price fluctuations. As of July 31, 2004,
we had several open positions in gold forward contracts totaling 54,500 fine
troy ounces, to purchase gold for $21.7 million. The fair value of gold under
such contracts was $21.5 million at July 31, 2004. These contracts have
settlement dates ranging from October 29, 2004 through March 31, 2005.
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
As of the end of our most recently completed fiscal quarter covered by
this report, we carried out an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer ("CEO")
and Chief Financial Officer ("CFO"), of the effectiveness of our disclosure
controls and procedures pursuant to Securities Exchange Act Rule 13a-15. Based
upon that evaluation,
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the CEO and CFO concluded that the design and operation of these disclosure
controls and procedures are effective in reaching a reasonable level of
assurance that material financial and non-financial information required to be
disclosed by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the Commission's rules and forms.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
There have been no changes in our internal controls over financial
reporting that occurred during our last fiscal quarter to which this report
relates that have materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting.
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PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
ISSUER PURCHASES OF EQUITY SECURITIES
There were no repurchases of equity securities made by us during the second
quarter of 2004.
On December 1, 2000, we announced that our 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, our Board of Directors approved the repurchase of an additional $20
million of outstanding Common Stock. We may, at the discretion of management,
purchase our Common Stock, from time to time through September 30, 2004 under
the stock repurchase program. Additionally, we currently expect the Board of
Directors to approve an extension of the stock repurchase program through
September 30, 2005. 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 our
cash position and requirements going forward. Through 2003, we repurchased a
total of 1,815,159 shares for approximately $20,537,000. For the twenty-six
weeks ended July 31, 2004 and August 2, 2003, we repurchased 392,745 shares and
225,688 shares for $6,862,000 and $2,848,000, respectively.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Stockholders of the Company was held on June
17, 2004, pursuant to notice, at which Messrs. Richard E. Kroon and Norman S.
Matthews and Ms. Ellen R. Levine were re-elected directors of the Company to
serve a three-year term in the class of directors whose term expires in 2007.
Such members have been elected to serve until the expiration of their respective
terms of office and until their successors are duly elected and qualified. At
such meeting, votes were cast as follows:
Name Votes For Votes Withheld
---- --------- --------------
Richard E. Kroon 8,182,817 5,300
Norman S. Matthews 8,150,438 37,679
Ellen R. Levine 8,187,204 913
Messrs. David B. Cornstein, Rohit M. Desai, Michael Goldstein, John D.
Kerin, Thomas M. Murnane and Arthur E. Reiner continued to serve as members of
the Board of Directors after the meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
10.1 Sixth Amendment, dated as of August 20, 2004, among Sovereign
Bank, as agent and a bank, Sovereign Precious Metals LLC,
Finlay Jewelry and eFinlay, Inc., to the Amended and Restated
Gold Consignment Agreement, dated as of March 30, 2001, as
amended.
10.2 Amendment No. 2, dated as of May 26, 2004, to the Second
Amended and Restated Credit Agreement, dated as of January 22,
2003, among Finlay Jewelry, Finlay Enterprises, General
Electric Capital Corporation, individually and in its capacity
as
34
administrative agent, Fleet Precious Metals, Inc.,
individually and as documentation agent, and certain other
banks and institutions.
11 Statement re: Computation of earnings per share (not required
because the relevant computation can be clearly determined
from material contained in the financial statements).
15 Not applicable.
18 Not applicable.
19 Not applicable.
22 Not applicable.
23 Not applicable.
24 Not applicable.
31.1 Certification of principal executive officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 302.
31.2 Certification of principal financial officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 302.
32.1 Certification of principal executive officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 906.
32.2 Certification of principal financial officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 906.
B. REPORTS ON FORM 8-K
On May 6, 2004, the Company filed a Current Report on Form 8-K furnishing
information under Item 12 relating to the Company's press release on May 6,
2004, announcing the Company's sales for the first quarter ended May 1, 2004.
On May 7, 2004, the Company filed a Current Report on Form 8-K providing
information under Item 5 relating to the Company's and Finlay Jewelry's press
release on May 7, 2004, announcing the commencement of cash tender offers to
purchase the Company's Senior Debentures and Finlay Jewelry's Senior Notes and
related consent solicitations.
On May 20, 2004, the Company filed a Current Report on Form 8-K furnishing
information under Item 12 relating to the Company's press release on May 20,
2004, reporting the Company's financial results for the first quarter ended May
1, 2004.
On May 20, 2004, the Company filed a Current Report on Form 8-K providing
information under Item 5 relating to the Company's and Finlay Jewelry's press
release on May 20, 2004, announcing the receipt of the requisite tenders and
consents from holders of the Company's Senior Debentures and Finlay Jewelry's
Senior Notes to amend the related indentures.
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On May 21, 2004, the Company filed a Current Report on Form 8-K providing
information under Item 5 relating to the Company's press release on May 21,
2004, announcing that Finlay Jewelry had commenced an offer to sell $200 million
of Senior Notes due 2012.
On May 28, 2004, the Company filed a current Report on Form 8-K providing
information under Item 5 relating to the Company's press release on May 27,
2004, announcing that Finlay Jewelry had priced its offering of $200 million of
Senior Notes due 2012.
On June 4, 2004, the Company filed a Current Report on Form 8-K providing
information under Item 5 relating to the Company's press release on June 3,
2004, announcing that Finlay Jewelry had completed its offering of $200 million
of Senior Notes due 2012.
On June 7, 2004, the Company filed a Current Report on Form 8-K providing
information under Item 5 relating to the Company's and Finlay Jewelry's press
release on June 7, 2004, announcing that the offers to purchase the Company's
Senior Debentures and Finlay Jewelry's Senior Notes expired at 12:00 midnight,
on June 4, 2004, and have not been extended.
On August 5, 2004, the Company filed a Current Report on Form 8-K
furnishing information under Item 12 relating to the Company's press release on
August 5, 2004, announcing the Company's sales for the second quarter and the
six months ended July 31, 2004.
On August 19, 2004, the Company filed a Current Report on Form 8-K
furnishing information under Item 12 relating to the Company's press release on
August 19, 2004, reporting the Company's financial results for the second
quarter and the six months ended July 31, 2004.
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SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: September 3, 2004 FINLAY ENTERPRISES, INC.
By: /s/ Bruce E. Zurlnick
-------------------------------------
Bruce E. Zurlnick
Senior Vice President, Treasurer
and Chief Financial Officer
(As both a duly authorized officer of
Registrant and as principal financial
officer of Registrant)
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