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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934*
For the fiscal year ended January 29, 2005 or
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__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number: 33-59380
FINLAY FINE JEWELRY CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 13-3287757
- ----------------------------- -------------------
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
529 Fifth Avenue New York, NY 10017
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(Address of principal executive offices) (Zip Code)
212-808-2800
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X*] No [ ]
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [x]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
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As of April 8, 2005, there were 1,000 shares of common stock, par value $.01 per
share, of the registrant outstanding. As of such date, all shares of common
stock were owned by the registrant's parent, Finlay Enterprises, Inc., a
Delaware corporation.
*The registrant is not subject to the filing requirements of Section 13 or 15(d)
of the Securities Exchange Act of 1934 and is voluntarily filing this Annual
Report on Form 10-K.
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FINLAY FINE JEWELRY CORPORATION
FORM 10-K
FOR THE FISCAL YEAR ENDED JANUARY 29, 2005
INDEX
PAGE(S)
-------
PART I
Item 1. Business....................................................................... 3
Item 2. Properties......................................................................12
Item 3. Legal Proceedings...............................................................12
Item 4. Submission of Matters to a Vote of Security Holders.............................13
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities....................................14
Item 6. Selected Consolidated Financial Data............................................15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..........................................17
Item 7A. Quantitative and Qualitative Disclosures about Market Risk......................36
Item 8. Financial Statements and Supplementary Data.....................................37
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..........................................37
Item 9A. Controls and Procedures.........................................................37
Item 9B. Other Information...............................................................39
PART III
Item 10. Directors and Executive Officers of the Registrant..............................40
Item 11. Executive Compensation..........................................................43
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters..................................................55
Item 13. Certain Relationships and Related Transactions..................................59
Item 14. Principal Accounting Fees and Services..........................................60
PART IV
Item 15. Exhibits, Financial Statement Schedules.........................................60
SIGNATURES ................................................................................67
2
PART I
ITEM 1. BUSINESS
--------
THE COMPANY
Finlay Fine Jewelry Corporation, a Delaware corporation, and its
wholly-owned subsidiaries ("Finlay Jewelry", the "Registrant", "we", "us" and
"our") is a wholly-owned subsidiary of Finlay Enterprises, Inc., a Delaware
corporation (the "Holding Company"). References to "Finlay" mean, collectively,
the Holding Company and Finlay Jewelry. All references herein to "departments"
refer to fine jewelry departments operated pursuant to license agreements with
host department stores.
We are one of the leading retailers of fine jewelry in the United States.
We operate licensed fine jewelry departments in major department stores for
retailers such as The May Department Stores Company ("May"), Federated
Department Stores, Inc. ("Federated"), Belk, the Carson Pirie Scott division of
Saks Incorporated and Dillard's. We sell a broad selection of moderately priced
fine jewelry, including necklaces, earrings, bracelets, rings and watches, and
market these items principally as fashion accessories with an average sales
price of approximately $201 per item. Average sales per department were $955,000
in 2004 and the average size of a department is approximately 800 square feet.
As of January 29, 2005, we operated our 962 locations in 16 host store
groups in 46 states and the District of Columbia. Our largest host store
relationship is with May, for which we have operated departments since 1948. We
operate in 481 of May's fine jewelry departments, representing substantially all
of May's department stores. Our second largest host store relationship is with
Federated, for which we have operated departments since 1983. We operate
departments in 113 of Federated's 458 department stores. During 2004, store
groups owned by May and Federated accounted for 59% (including Marshall Field's
for the 2004 fiscal year) and 19%, respectively, of our sales. Our management
believes that we maintain excellent relations with our host store groups, 15 of
which have had license agreements with us for more than five years (representing
91% of our sales in 2004) and twelve of which have had license agreements with
us for more than ten years (representing 76% of our sales in 2004).
On February 28, 2005, Federated and May announced that they have entered
into a merger agreement whereby Federated would acquire May. The transaction is
expected to close in the third quarter of 2005. The completion of the merger is
contingent upon regulatory review and approval by the shareholders of both
companies. Finlay's license agreements with May are terminable as follows:
Robinsons-May/Meier & Frank, Filene's/Kaufmann's and Famous Barr/L.S.
Ayres/Jones on January 28, 2006, Foley's, Hecht's/Strawbridge's and Lord &
Taylor on February 3, 2007 and Marshall Field's on April 2, 2008. Finlay's
license agreements with Federated are terminable as follows:
Rich's-Macy's/Lazarus-Macy's/Goldsmith's-Macy's and Bon-Macy's on January 28,
2006 and Bloomingdale's on February 3, 2007. We cannot anticipate the impact of
the proposed transaction on our future results of operations and there is no
assurance that we will not be adversely impacted.
On March 1, 2005, the Holding Company announced that it is in advanced
discussions regarding a possible acquisition of Carlyle & Co. Jewelers
("Carlyle"). Carlyle is a privately-owned regional chain, located primarily in
the southeastern United States, with 32 jewelry stores and annual sales of
approximately $80.0 million. Finlay is presently engaged in its due diligence
review of Carlyle.
During the second quarter of 2004, we and the Holding Company completed the
redemption of our then-outstanding 8-3/8% Senior Notes, due May 1, 2008, having
an aggregate principal amount of $150.0 million (the "Senior Notes") and the 9%
Senior Debentures, due May 1, 2008, having an aggregate principal amount of
$75.0 million (the "Senior Debentures"). Additionally, in June 2004, we
completed the sale of the 8-3/8% Senior Notes, due June 1, 2012, having an
aggregate principal amount of $200.0 million (the "New Senior Notes"). These
transactions were undertaken to decrease our overall interest rate, extend our
debt maturities and decrease total long-term debt as well as simplify our
capital structure by eliminating debt at the parent company level.
3
During 2003, Federated announced that it would not renew our license
agreement in its Burdines department store division due to the consolidation of
the Burdines and Macy's fine jewelry departments in 2004. The termination of the
license agreement in January 2004 resulted in the closure of 46 Finlay
departments in the Burdines department store division. In 2003, we generated
approximately $55 million in sales from the Burdines departments. Additionally,
in 2003, May announced its intention to divest 32 Lord & Taylor stores as well
as two other stores in its Famous-Barr division, resulting in the closure of 18
departments in 2004, which generated approximately $10.6 million in sales.
Through January 29, 2005, a total of 27 of these stores have closed.
On January 22, 2003, our revolving credit agreement with General Electric
Capital Corporation ("G.E. Capital") and certain other lenders was amended and
restated (the "Revolving Credit Agreement"). The Revolving Credit Agreement,
which matures in January 2008, provides us with a senior secured revolving line
of credit up to $225.0 million (the "Revolving Credit Facility").
Our fiscal year ends on the Saturday closest to January 31. References to
2005, 2004, 2003, 2002, 2001 and 2000 relate to the fiscal years ending on
January 28, 2006, January 29, 2005, January 31, 2004, February 1, 2003, February
2, 2002 and February 3, 2001, respectively. Each of the fiscal years includes 52
weeks except 2000, which includes 53 weeks.
We were initially incorporated on August 2, 1985 as SL Holdings Corporation
("SL Holdings"). The Holding Company, a Delaware corporation incorporated on
November 22, 1988, was organized by certain officers and directors of SL
Holdings to acquire certain operations of SL Holdings. In connection with a
reorganization transaction in 1988, which resulted in the merger of a
wholly-owned subsidiary of the Holding Company into SL Holdings, SL Holdings
changed its name to Finlay Fine Jewelry Corporation and became a wholly-owned
subsidiary of the Holding Company. Our principal executive offices are located
at 529 Fifth Avenue, New York, New York 10017 and our telephone number at this
address is (212) 808-2800.
GENERAL
OVERVIEW. Host stores benefit from outsourcing the operation of their fine
jewelry departments. By engaging us, host stores gain specialized managerial,
merchandising, selling, marketing, inventory control and security expertise.
Additionally, by avoiding the high working capital investment typically required
of the jewelry business, host stores improve their return on investment and can
potentially increase their profitability.
As a licensee, we benefit from the host stores' reputation, customer
traffic, advertising, credit services and established customer base. We also
avoid the substantial capital investment in fixed assets typical of stand-alone
retail formats. These factors have generally enabled our new departments to
achieve profitability within their first twelve months of operation. We further
benefit because net sales proceeds are generally remitted to us by each host
store on a monthly basis with essentially all customer credit risk borne by the
host store.
As a result of our strong relationships with our vendors, our management
believes that our working capital requirements are lower than those of many
other jewelry retailers. In recent years, on average, approximately 50% of our
merchandise has been carried on consignment. The use of consignment merchandise
also reduces our inventory exposure to changing fashion trends because unsold
consigned merchandise can be returned to the vendor.
INDUSTRY. Our management believes that current trends in jewelry retailing
provide a significant opportunity for our growth. Consumers spent approximately
$57.0 billion on jewelry (including both fine and costume jewelry) in the United
States in 2004, an increase of approximately $21.0 billion over 1994, according
to the United States Department of Commerce. In the department store sector in
which we operate, consumers spent an estimated $4.1 billion on fine jewelry in
2003. Our management believes that demographic factors such as the maturing U.S.
population and an increase in the number of working
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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. Our departments are typically located in "high traffic" areas of leading
department stores, enabling us to capitalize on these consumer buying patterns.
GROWTH STRATEGY. We intend to continue to pursue the following key
initiatives to increase sales and earnings:
o INCREASE COMPARABLE DEPARTMENT SALES. Our merchandising and marketing
strategy includes emphasizing key merchandise items, increasing focus on
holiday and event-driven promotions, participating in host store marketing
programs and positioning our departments as "destination locations" for
fine jewelry. We believe that comparable department sales (sales from
departments open for the same months during the comparable period) will
continue to benefit from these strategies. Over the past decade, we have
experienced comparable store sales increases (in nine out of ten years) and
have consistently outperformed our host store groups with respect to these
increases.
o ADD DEPARTMENTS WITHIN EXISTING HOST STORE GROUPS. Our well established
relationships with many of our host store groups have enabled us to add
departments in new locations opened by existing host stores. We also seek
to open new departments within existing host stores that do not currently
operate jewelry departments. We have operated departments in May stores
since 1948 and operate in 481 of May's fine jewelry departments,
representing substantially all of May's department stores. We have also
operated departments in Federated stores since 1983 and operate departments
in 113 of Federated's 458 department stores.
o ESTABLISH NEW HOST STORE RELATIONSHIPS. We have an opportunity to grow by
establishing new relationships with department stores that presently
operate their own fine jewelry departments or have an interest in opening
jewelry departments. We seek to establish these new relationships by
demonstrating to department store management the potential for improved
financial performance. Through acquisitions, we have added Marshall
Field's, Parisian, Dillard's and Bloomingdale's to our host store
relationships.
o OPEN NEW CHANNELS OF DISTRIBUTION. An important initiative and focus of
management is finding new opportunities for growth. We seek to identify
complementary businesses, such as one or more regional jewelry chains, to
leverage our core competencies in the jewelry industry. The Holding
Company's proposed acquisition of Carlyle, discussed above, represents a
retail format different from the licensed department store business. In
November 2003, we began a relationship with SmartBargains.com, LP
("SmartBargains") to provide jewelry via its internet site and successfully
absorbed this e-business fulfillment into our distribution center.
o IMPROVE OPERATING LEVERAGE. We seek to continue to leverage expenses both
by increasing sales at a faster rate than expenses and by reducing our
current level of certain operating expenses. For example, we have
demonstrated that by increasing the selling space (with host store
approval) of certain high volume departments, incremental sales can be
achieved without having to incur proportionate increases in selling and
administrative expenses. In addition, our management believes we will
benefit from further investments in technology and refinements of operating
procedures designed to allow our sales associates more time for customer
sales and service. Our merchandising and inventory control system and our
point-of-sale system for our departments provide the foundation for
improved productivity and expense control initiatives. Further, our central
distribution facility has enabled us to improve the flow of merchandise to
departments and to reduce payroll and freight costs.
5
o ENHANCE CUSTOMER SERVICE STANDARDS AND STRENGTHEN SELLING TEAMS. We are
continuously developing and evaluating our selling teams. One of our
priorities is to effectively manage personnel at our store locations, as
they are the talent driving our business at the critical point of sale. We
place strong emphasis on training and customer service. Over the past
twelve months, we added trainers and expanded our interactive, web-based
training programs to provide our associates with a uniform training
experience. We believe our training initiatives have increased, and will
continue to enhance, selling productivity. In order to further our goals of
optimizing service levels and driving sales growth, we will continue to
incentivize our sales associates by providing performance-based
compensation and recognition.
MERCHANDISING STRATEGY. We seek to maximize sales and profitability through
a unique merchandising strategy known as the "Finlay Triangle", which integrates
store management (including host store management and our store group
management), vendors and our central office. By coordinating efforts and sharing
access to information, each Finlay Triangle participant plays a role which
emphasizes its area of expertise in the merchandising process, thereby
increasing productivity. Within guidelines set by the central office, our store
group management contributes to the selection of the specific merchandise most
appropriate to the demographics and customer tastes within their particular
geographical area. Our advertising initiatives and promotional planning are
closely coordinated with both host store management and our store group
management to ensure the effective use of our marketing programs. Vendors
participate in the decision-making process with respect to merchandise
assortment, including the testing of new products, marketing, advertising and
stock levels. By utilizing the Finlay Triangle, opportunities are created for
the vendor to assist in identifying fashion trends thereby improving inventory
turnover and profitability, both for the vendor and us. As a result, our
management believes it capitalizes on economies of scale by centralizing certain
activities, such as vendor selection, advertising and planning, while allowing
store management the flexibility to implement merchandising programs tailored to
the host store environments and clientele.
THE FINLAY TRIANGLE
[GRAPHIC OMITTED]
FINLAY
MERCHANDISING
TEAM
VENDORS STORE
MANAGEMENT
We have structured our relationships with vendors to encourage sharing of
responsibility for marketing and merchandise management. We furnish to vendors,
through on-line access to our information systems, the same sales, stock and
gross margin information that is available to our store group management and
central office for each of the vendor's styles in our merchandise assortment.
Using this information, vendors are able to participate in decisions to
replenish inventory which has been sold and to return or exchange slower-moving
merchandise. New items are tested in specially selected "predictor" departments
where sales experience can indicate an item's future performance in our other
departments. Our management believes that the access and input which vendors
have in the merchandising process results in a better assortment, more timely
replenishment, higher turnover and higher sales of inventory, differentiating us
from our competitors.
Since many of the host store groups in which we operate differ in fashion
image and customer demographics, our flexible approach to merchandising is
designed to complement each host store's own merchandising philosophy. We
emphasize a "fashion accessory" approach to fine jewelry and watches, and seek
to provide items that coordinate with the host store's fashion focus as well as
to maintain stocks of traditional and gift merchandise.
6
STORE RELATIONSHIPS
HOST STORE RELATIONSHIPS. Our relations with our host store groups, 15 of
which have had license agreements with us for more than five years (representing
91% of our sales in 2004) and twelve of which have had license agreements with
us for more than ten years (representing 76% of our sales in 2004), provide
strong and, in many instances, long-term relationships such that license
agreements are routinely renewed.
The following table identifies the host store groups in which we operated
departments at January 29, 2005, the year in which our relationship with each
host store group commenced and the number of departments operated by us in each
host store group.
HOST STORE GROUP INCEPTION OF NUMBER OF
RELATIONSHIP DEPARTMENTS
------------ -----------
MAY
Robinsons-May/Meier & Frank.................................... 1948 74
Filene's/Kaufmann's............................................ 1977 99
Lord & Taylor.................................................. 1978 62
Famous Barr/L.S. Ayres/Jones................................... 1979 42
Foley's........................................................ 1986 69
Hecht's/Strawbridge's.......................................... 1986 81
Marshall Field's............................................... 1997 54
---
Total May Departments...................................... 481
FEDERATED
Rich's-Macy's/Lazarus-Macy's/Goldsmith's-Macy's (1)............ 1983 60
Bon-Macy's (1)................................................. 1993 23
Bloomingdale's................................................. 2000 30
---
Total Federated Departments................................ 113
SAKS INCORPORATED
Carson Pirie Scott/Bergner's/Boston Store/Younkers/Herberger's. 1973 83
Parisian....................................................... 1997 32
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Total Saks Incorporated Departments........................ 115
OTHER DEPARTMENTS
Gottschalks.................................................... 1969 38
Belk's......................................................... 1975 67
The Bon-Ton/Elder Beerman...................................... 1986 78
Dillard's...................................................... 1997 70
---
Total Other Departments.................................... 253
---
Total Departments.......................................... 962
===
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(1) Effective in March, 2005, Federated changed the name of these groups to
Macy's.
7
TERMS OF LICENSE AGREEMENTS. Our license agreements typically have an
initial term of one to five years. Substantially all of our license agreements
contain renewal options or provisions for automatic renewal absent prior notice
of termination by either party. License agreement renewals are generally for one
to three year periods. In exchange for the right to operate a department within
the host store, we pay each host store group a license fee, calculated as a
percentage of sales (subject to a minimum annual fee in a limited number of
cases).
Our license 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, substantially all of our license 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 each such month. Each host store group withholds
from the remittance of sales proceeds a license fee and other expenditures, such
as advertising costs, which the host store group may have incurred on our
behalf.
We are usually responsible for providing and maintaining any fixtures and
other equipment necessary to operate our departments, while the host store is
typically required to provide clean space for installation of any necessary
fixtures. The host store is generally responsible for paying utility costs
(except certain telephone charges), maintenance and certain other expenses
associated with the operation of the departments. Our license agreements
typically provide that we are responsible for the hiring (subject to the
suitability of such employees to the host store) and discharge of our sales and
department supervisory personnel, and substantially all license agreements
require us to provide our employees with salaries and certain benefits
comparable to those received by the host store's employees. Many of our license
agreements provide that we may operate the departments in any new stores opened
by the host store group. In certain instances, we are operating departments
without written agreements, although the arrangements in respect of such
departments are generally in accordance with the terms described herein.
In several cases, we are subject to limitations under our license
agreements which prohibit us from operating departments for competing host store
groups within a certain geographical radius of the host stores (typically five
to ten miles). Such limitations restrict us from further expansion within areas
where we currently operate departments, including expansion by possible
acquisitions. Certain license agreements, however, make an exception for adding
departments in stores established by groups with which we have a preexisting
license agreement. In addition, we have from time to time obtained the consent
of an existing host store group to operate in another host store group within a
prohibited area. For example, May and Federated have granted consents of this
type to us with respect to one another's stores. Further, we have sought and
received the consent of certain of our existing host store groups in connection
with past acquisitions.
CREDIT. Substantially all consumer credit risk is borne by the host store
rather than by us. Purchasers of our merchandise at a host store are entitled to
the use of the host store's credit facilities on the same basis as all of the
host store's customers. Payment of credit card or check transactions is
generally guaranteed to us by the host store, provided that the proper credit
approvals have been obtained in accordance with the host store's policy.
Accordingly, payment to us in respect of our sales proceeds is generally not
dependent on when, or if, payment is received by the host store.
DEPARTMENTS OPENED/CLOSED. During 2004, department openings offset by
closings resulted in a net decrease of ten departments. The openings, which
totaled 28 departments, including eleven departments in Dillard's, were all
within existing store groups. The closings totaled 38 departments and included
17 Lord & Taylor departments as well as one Famous Barr department as a result
of May's decision to close these smaller, less profitable locations. The balance
of the closings were within existing store groups. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations-2004 Compared with
2003".
8
The following table sets forth data regarding the number of departments
which we have operated from the beginning of 2000:
FISCAL YEAR ENDED
---------------------------------------------------------
JAN. 29, JAN. 31, FEB. 1, FEB. 2, FEB. 3,
2005 2004 2003 2002 2001
-------- --------- -------- --------- ---------
DEPARTMENTS:
Open at beginning of year .............. 972 1,011 1,006 1,053 987
Opened during year ..................... 28 32 21 33 86
Closed during year ..................... (38) (71) (16) (80) (20)
-------- -------- -------- -------- --------
Open at end of year .................... 962 972 1,011 1,006 1,053
-------- -------- -------- -------- --------
Net increase (decrease) ................ (10) (39) 5 (47) 66
======== ======== ======== ======== ========
For the years presented in the table above, department closings were
primarily attributable to: ownership changes in host store groups; internal
consolidation within host store groups; the closing or sale by host store groups
of individual stores; host store group decisions to consolidate with one
licensee or to operate departments themselves; and our decision to close
unprofitable departments. To our management's knowledge, none of the department
closings during the periods presented in the table above resulted from
dissatisfaction of a host store group with our performance.
PRODUCTS AND PRICING
Each of our departments offers a broad selection of necklaces, earrings,
bracelets, rings and watches. Other than watches, substantially all of the fine
jewelry items sold by us are made from precious metals and many also contain
diamonds or colored gemstones. We also provide jewelry and watch repair
services. We do not carry costume or gold-filled jewelry. Specific brand
identification is generally not important within the fine jewelry business,
except for watches and designer jewelry. With respect to watches, we emphasize
brand name vendors, including Citizen, Bulova, Movado and Seiko. Many of our
license agreements with host store groups restrict us from selling certain types
of merchandise or, in some cases, selling particular merchandise below certain
price points.
The following table sets forth the sales and percentage of sales by
category of merchandise for 2004, 2003 and 2002:
FISCAL YEAR ENDED
-----------------------------------------------------------------
JAN. 29, 2005 JAN. 31, 2004 FEB. 1, 2003
------------------- ------------------- -------------------
% OF % OF % OF
SALES SALES SALES SALES SALES SALES
-------- -------- -------- -------- -------- --------
(DOLLARS IN MILLIONS)
Diamonds ............................... $ 244.0 26.4% $ 232.6 25.8% $ 217.8 24.8%
Gold ................................... 197.3 21.4 196.9 21.8 196.0 22.3
Gemstones .............................. 196.8 21.3 198.0 22.0 196.3 22.4
Watches ................................ 132.0 14.3 134.0 14.8 134.3 15.3
Designer ............................... 53.2 5.8 42.6 4.7 33.0 3.8
Other (1) .............................. 100.3 10.8 98.3 10.9 99.9 11.4
-------- -------- -------- -------- -------- --------
Total Sales ............................ $ 923.6 100.0% $ 902.4 100.0% $ 877.3 100.0%
======== ======== ======== ======== ======== ========
- ----------
(1) Includes special promotional items, remounts, estate jewelry, pearls,
beads, cubic zirconia, sterling silver and men's jewelry, as well as repair
services and accommodation sales to our employees.
We sell our merchandise at prices generally ranging from $50 to $1,000. In
2004, the average price of items sold by us was approximately $201 per item. An
average department has over 5,000 items in stock. Consistent with fine jewelry
retailing in general, a substantial portion of our sales are made at prices
discounted from listed retail prices. Our advertising and promotional planning
are closely coordinated with our pricing strategy. Publicized sales events are
an important part of our marketing efforts. A substantial portion of our sales
occur during such promotional events. The amount of time during which
9
merchandise may be offered at discount prices is limited by applicable laws and
regulations. See "Legal Proceedings".
PURCHASING AND INVENTORY
GENERAL. A key element of our strategy has been to lower the working
capital investment required for operating our existing departments and opening
new departments. In recent years, on average, approximately 50% of our
merchandise has been obtained on consignment and certain additional inventory
has been purchased with extended payment terms. In 2004, our net monthly
investment in inventory (i.e., the total cost of inventory owned and paid for)
averaged 35% of the total cost of our on-hand merchandise. We are generally
granted exchange privileges which permit us to return or exchange unsold
merchandise for new products at any time. In addition, we structure our
relationships with vendors to encourage their participation in and
responsibility for merchandise management. By making the vendor a participant in
our merchandising strategy, we have created opportunities for the vendor to
assist in identifying fashion trends, thereby improving inventory turnover and
profitability. As a result, our direct capital investment in inventory has been
reduced to levels which we believe are low for the retail jewelry industry. In
addition, our inventory exposure to changing fashion trends is reduced because
unsold consignment merchandise can be returned to the vendor.
In 2004, merchandise obtained from our 40 largest vendors (out of a total
of approximately 500 vendors) generated approximately 82% of sales, and
merchandise obtained from our largest vendor generated approximately 10% of
sales. We do not believe the loss of any one of our vendors would have a
material adverse effect on our business.
GOLD CONSIGNMENT AGREEMENT. We are a party to an amended and restated gold
consignment agreement (as amended, the "Gold Consignment Agreement"), which
enables us 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. Our Gold Consignment Agreement matures on July
31, 2005, and permits us 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. We are currently in the process of extending
the term of the Gold Consignment Agreement. At January 29, 2005, amounts
outstanding under the Gold Consignment Agreement totaled 116,687 fine troy
ounces, valued at approximately $49.8 million. The average amount outstanding
under the Gold Consignment Agreement was $48.9 million for the fiscal year ended
January 29, 2005. In the event this arrangement is terminated, we will be
required to return the gold or purchase the outstanding gold at the prevailing
gold rate in effect on that date.
Under the Gold Consignment Agreement, we are required to pay a daily
consignment fee on the dollar equivalent of the fine gold value of the ounces of
gold consigned thereunder. The daily consignment fee is based on a floating rate
which, as of January 29, 2005, was 2.8% per annum. In conjunction with the Gold
Consignment Agreement, we granted to the gold consignor a first priority
perfected lien on, and a security interest in, specified gold jewelry of
participating vendors approved under the Gold Consignment Agreement and a lien
on proceeds and products of such jewelry, subject to the terms of an
intercreditor agreement between the gold consignor and the Revolving Credit
Agreement lenders.
OPERATIONS
GENERAL. Most of our departments have between 50 and 150 linear feet of
display cases (with an average of approximately 80 linear feet) generally
located in high traffic areas on the main floor of the host stores. Each
department is supervised by a manager whose primary duties include customer
sales and service, scheduling and training of personnel, maintaining security
controls and merchandise presentation. Each department is open for business
during the same hours as its host store.
10
To parallel host store operations, we have established separate group
service organizations responsible for managing departments operated for each
host store. Staffing for each group organization varies with the number of
departments in each group. Typically, we service each host store group with a
group manager, an assistant group manager, one group buyer, three or more
regional supervisors who oversee the individual department managers and a number
of clerical employees. Each group manager reports to a regional vice president,
who is responsible for the supervision of up to five host store groups. In our
continued efforts to improve comparable department sales through improved
operating efficiency, we have taken steps to minimize administrative tasks at
the department level, to improve customer service and, as a result, sales.
We had average sales per linear foot of approximately $12,000 in 2004, and
$11,700 in both 2003 and 2002. We determine average sales per linear foot by
dividing our sales by the aggregate estimated measurements of the outer
perimeters of the display cases of our departments. We had average sales per
department of approximately $955,000, $932,000 and $911,000 in 2004, 2003 and
2002, respectively.
MANAGEMENT INFORMATION AND INVENTORY CONTROL SYSTEMS. We, along with our
vendors, use our management information systems to monitor sales, gross margin
and inventory performance by location, merchandise category, style number and
vendor. Using this information, we are able to monitor merchandise trends and
variances in performance and improve the efficiency of our inventory management.
We also measure the productivity of our sales force by maintaining current
statistics for each employee such as sales per hour, transactions per hour and
transaction size. Our merchandising and inventory control system and
point-of-sale system for our departments have provided improved analysis and
reporting capabilities. Additionally, these systems provide the foundation for
improved productivity and expense control initiatives.
PERSONNEL AND TRAINING. We consider our employees an important component of
our operations and devote substantial resources to training and improving the
quality of sales and management personnel.
As of the end of 2004, we regularly employed approximately 6,000 people of
which approximately 95% were regional and local sales and supervisory personnel
and the balance were employed in administrative or executive capacities. Of our
6,000 employees, approximately 3,000 were part-time employees, working less than
32 hours per week. Our labor requirements fluctuate because of the seasonal
nature of our business. Our management believes that relations with our
employees are good. Less than 1% of our employees are unionized.
ADVERTISING. We promote our products through four-color direct mail
catalogs, using targeted mailing lists, and newspaper advertising of the host
store groups. We maintain an in-house advertising staff responsible for
preparing a majority of our advertisements and for coordinating the finished
advertisements with the promotional activities of the host stores. Our gross
advertising expenditures over the past five fiscal years have been approximately
5% of sales, a level which is consistent with the jewelry industry's reliance on
promotional efforts to generate sales. The majority of our license agreements
with host store groups require us to expend certain specified minimum
percentages of the respective department's annual sales on advertising and
promotional activities.
INVENTORY LOSS PREVENTION AND INSURANCE. We undertake substantial efforts
to safeguard our merchandise from loss or theft, including the installation of
safes and lockboxes at each location and the taking of a daily diamond inventory
count. During 2004, inventory shrinkage amounted to approximately 0.4% of sales.
We maintain insurance covering the risk of loss of merchandise in transit or on
our premises (whether owned or on consignment) in amounts that management
believes are reasonable and adequate for the types and amounts of merchandise we
carry.
GOLD HEDGING. The cost to us of gold merchandise sold on consignment in
some cases is not fixed until the sale is reported to the vendor or the gold
consignor in the case of merchandise sold pursuant to the Gold Consignment
Agreement. In such cases, the cost of merchandise varies with the price of gold
and we are exposed to the risk of fluctuations in the price of gold between the
time we establish the
11
advertised or other retail price of a particular item of merchandise and the
date on which the sale of the item is reported to the vendor or the gold
consignor. In order to hedge against this risk and to enable us to determine the
cost of such goods prior to their sale, we may elect to fix the price of gold
prior to the sale of such merchandise. Accordingly, we, at times, enter into
forward contracts, based upon the anticipated sales of gold product in order to
hedge against the risk arising from our payment arrangements. The value of gold
hedged under such contracts represented approximately 8% of our cost of goods
sold in 2004. Under such contracts, we obtain the right to purchase a fixed
number of fine troy ounces of gold at a specified price per ounce for a
specified period. Such contracts typically have durations ranging from one to
nine months and are generally priced at the spot gold price plus an amount based
on prevailing interest rates plus customary transaction costs. When sales of
such merchandise are reported to the consignment vendors and the cost of such
merchandise becomes fixed, we sell our related hedge position. At January 29,
2005, we had several open positions in gold forward contracts totaling 37,000
fine troy ounces, to purchase gold for $16.1 million, which expire during 2005.
The fair market value of gold under such contracts was approximately $15.8
million at January 29, 2005.
We manage the purchase of forward contracts by estimating and monitoring
the quantity of gold that we anticipate will be required in connection with our
anticipated level of sales of the type described above. Our gold hedging
transactions are entered into in the ordinary course of business. Our gold
hedging strategies are determined and monitored on a regular basis by our senior
management and our Board of Directors.
COMPETITION
We face competition for retail jewelry sales from national and regional
jewelry chains, other department stores, local independently owned jewelry
stores and chains, specialty stores, mass merchandisers, catalog showrooms,
discounters, direct mail suppliers, televised home shopping and internet
merchants. Our management believes that competition in the retail jewelry
industry is based primarily on the price, quality, fashion appeal and perceived
value of the product offered and on the reputation, integrity and service of the
retailer. See "--Store Relationships--Terms of License Agreements" with respect
to certain limitations on our ability to compete.
SEASONALITY
Our business is subject to substantial seasonal variations. Historically,
we have realized a significant portion of our sales, cash flow and net income in
the fourth quarter of the year principally due to sales from the holiday season.
We expect that this general pattern will continue. Our results of operations may
also fluctuate significantly as a result of a variety of other factors,
including the timing of new store openings and store closings.
ITEM 2. PROPERTIES
----------
The only real estate owned by us is the central distribution facility,
totaling 106,200 square feet at 205 Edison Avenue, Orange, Connecticut. We lease
approximately 18,400 square feet at 521 Fifth Avenue, New York, New York, and
49,100 square feet at 529 Fifth Avenue, New York, New York for our executive,
accounting, advertising, merchandising, information services and other
administrative functions. The leases for such space expire September 30, 2008.
Generally, as part of our license agreements, host stores provide office space
to our host store group management personnel free of charge.
ITEM 3. LEGAL PROCEEDINGS
-----------------
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 April 8, 2005, 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 consolidated
financial statements. However, the results of these matters cannot be predicted
with
12
certainty, and an unfavorable resolution of one or more of these matters could
have a material adverse effect on our consolidated financial statements.
Commonly in the retail jewelry industry, a substantial amount of
merchandise is sold at a discount to the "regular" or "original" price. Our
experience is consistent with this practice. A number of states in which we
operate have regulations which require retailers who offer merchandise at
discounted prices to offer the merchandise at the "regular" or "original" prices
for stated periods of time. Our management believes we are in substantial
compliance with all applicable legal requirements with respect to such
practices.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of 2004.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
----------------------------------------------------------------------
During 2004, we distributed cash dividends of $39.7 million to the Holding
Company. Additionally, we repaid an intercompany tax liability due to the
Holding Company totaling $43.4 million. During 2003, we distributed cash
dividends of $13.5 million to the Holding Company. The distributions were
generally utilized to repurchase the outstanding Senior Debentures, to pay
interest on the Senior Debentures and to purchase the Holding Company's common
stock, par value $.01 per share ("Common Stock"), under its stock repurchase
program. Certain restrictive covenants in the indenture relating to the New
Senior Notes, the Revolving Credit Agreement and the Gold Consignment Agreement
impose limitations on the payment of dividends to the Holding Company.
Additionally, the New Senior Notes, the Revolving Credit Agreement and the Gold
Consignment Agreement currently restrict the amount of annual distributions to
the Holding Company, including those required to fund stock repurchases.
Information regarding the Holding Company's equity compensation plans is
set forth in Item 12 of Part III of this Form 10-K, which information is
incorporated herein by reference.
There was one record holder of our common stock at April 8, 2005.
ISSUER PURCHASES OF EQUITY SECURITIES
We are a wholly-owned subsidiary of the Holding Company. Accordingly, there
is no established public trading market for our common stock.
14
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
------------------------------------
The selected consolidated financial information below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and Notes
thereto. The statement of operations data and balance sheet data as of and for
each of the years ended January 29, 2005, January 31, 2004, February 1, 2003,
February 2, 2002 and February 3, 2001 have been derived from our audited
Consolidated Financial Statements.
FISCAL YEAR ENDED (1)
-----------------------------------------------------------------
JAN. 29, JAN. 31, FEB. 1, FEB. 2, FEB. 3,
2005 2004 (2) 2003 (2) 2002 (2) 2001 (2)
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Sales ............................................... $ 923,606 $ 902,416 $ 877,296 $ 900,628 $ 944,756
Cost of sales ....................................... 454,391 440,517 424,846 453,246 469,058
--------- --------- --------- --------- ---------
Gross margin (3) .................................... 469,215 461,899 452,450 447,382 475,698
Selling, general and administrative expenses ........ 396,185 387,501 378,095 374,085 388,601
Credit associated with the closure of Sonab (4) ..... (364) -- (1,432) -- --
Depreciation and amortization ....................... 17,319 17,026 16,827 19,348 16,878
--------- --------- --------- --------- ---------
Income from operations .............................. 56,075 57,372 58,960 53,949 70,219
Interest expense, net ............................... 20,179 16,556 17,678 19,635 22,562
Other expense - debt extinguishment costs (5) ....... 5,962 -- -- -- --
--------- --------- --------- --------- ---------
Income from continuing operations before
income taxes and cumulative effect of
accounting change ................................. 29,934 40,816 41,282 34,314 47,657
Provision for income taxes (6) ...................... 10,447 16,035 16,064 14,369 20,088
--------- --------- --------- --------- ---------
Income from continuing operations before
cumulative effect of accounting change ............ 19,487 24,781 25,218 19,945 27,569
Discontinued operations, net of tax (2) ............. -- (11,537) 3,810 3,382 3,860
Cumulative effect of accounting change,
net of tax (7) .................................... -- -- (17,209) -- --
--------- --------- --------- --------- ---------
Net income ........................................ $ 19,487 $ 13,244 $ 11,819 $ 23,327 $ 31,429
========= ========= ========= ========= =========
OPERATING AND FINANCIAL DATA:
Number of departments (end of year) ................ 962 972 1,011 1,006 1,053
Percentage increase (decrease) in sales ............ 2.3% 2.9% (2.6)% (4.7)% 9.7%
Percentage increase (decrease) in comparable
department sales (8) ............................. 2.7% 2.3% 0.1% (3.0)% 2.1%
Average sales per department (9) ................... $ 955 $ 932 $ 911 $ 916 $ 970
EBITDA (10) ........................................ 73,394 74,398 75,787 73,297 87,097
Capital expenditures ............................... 12,667 12,934 12,489 13,850 18,118
CASH FLOWS PROVIDED FROM (USED IN):
Operating activities ............................... $ (14,172) $ 48,279 $ 52,291 $ 43,658 $ 34,455
Investing activities ............................... (12,667) (12,934) (15,750) (17,432) (30,403)
Financing activities ............................... (685) (14,349) (17,278) (8,253) (7,640)
BALANCE SHEET DATA-END OF PERIOD:
Working capital .................................... $ 229,886 $ 197,297 $ 173,960 $ 173,334 $ 152,003
Total assets ....................................... 558,477 592,324 578,575 583,422 602,254
Short-term debt, including current portion of
long-term debt ................................... -- -- -- -- --
Long-term debt ..................................... 200,000 150,000 150,000 150,000 150,000
Total stockholders' equity ......................... 164,857 185,100 187,816 193,596 179,423
- ----------
(1) Each of the fiscal years for which information is presented includes 52
weeks except 2000, which includes 53 weeks.
(2) As a result of Federated's decision not to renew our license agreement in
the Burdines department store division in 2003, and in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets", the results of
operations of the Burdines departments have been segregated from continuing
operations and reflected as a discontinued operation for financial
statement purposes for 2000, 2001, 2002 and
15
2003. Refer to Note 11 of Notes to Consolidated Financial Statements for
additional information regarding discontinued operations.
(3) We utilize the last-in, first-out ("LIFO") method of accounting for
inventories. If we had valued inventories using the first-in, first-out
inventory valuation method, the gross margin would have increased as
follows: $2.1 million, $4.5 million, $2.2 million, $3.6 million and $1.7
million for 2004, 2003, 2002, 2001 and 2000, respectively. During the third
quarter of 2004, we changed our method of determining price indices used in
the valuation of LIFO inventories. Refer to Note 3 of Notes to Consolidated
Financial Statements for additional information regarding this change in
accounting method.
(4) Included in Credit associated with the closure of Sonab for 2004 and 2002
is a $0.4 million and $1.4 million credit, respectively, which represents a
revision of our estimate of closure expenses to reflect our remaining
liability associated with the closure of Sonab. Refer to Note 15 of Notes
to Consolidated Financial Statements for additional information regarding
Sonab.
(5) During the second quarter of 2004, we refinanced the Senior Notes. Included
in Other expense - debt extinguishment costs for the year ended January 29,
2005 are pre-tax charges of approximately $6.0 million, including $4.4
million for redemption premiums paid on the Senior Notes, $1.3 million to
write-off deferred financing costs related to the refinancing of Senior
Notes and $0.3 million for other expenses. Refer to Note 5 of Notes to
Consolidated Financial Statements for additional information regarding the
debt refinancing.
(6) Included in Provision for income taxes for 2004 is approximately a $1.0
million benefit associated with the reversal of tax accruals no longer
required. Additionally, included in 2004 is a $0.6 million benefit
associated with tax refunds related to Sonab. Refer to Note 10 of Notes to
Consolidated Financial Statements.
(7) In accordance with the provisions of the Financial Accounting Standards
Board's ("FASB") Emerging Issues Task Force ("EITF") Issue No. 02-16,
"Accounting by a Customer (Including a Reseller) for Cash Consideration
Received from a Vendor" ("EITF 02-16"), we recorded a cumulative effect of
accounting change as of February 3, 2002, the date of adoption, that
decreased net income for 2002 by $17.2 million, net of tax of $11.7
million. The application of EITF 02-16 changed our accounting treatment for
the recognition of vendor allowances. In 2004, 2003 and 2002 $18.2 million,
$19.4 million and $18.9 million, respectively, of vendor allowances has
been reflected as a reduction to cost of sales. In 2000 and 2001, these
allowances were recorded as a reduction to gross advertising expenses and
thus decreased selling, general and administrative expenses ("SG&A"). Refer
to Note 2 of Notes to Consolidated Financial Statements for additional
information regarding EITF 02-16.
(8) Comparable department sales are calculated by comparing sales from
departments open for the same months in the comparable periods.
(9) Average sales per department is determined by dividing sales by the average
of the number of departments open at the beginning and at the end of each
period.
(10) EBITDA, a non-GAAP financial measure, represents income from operations
before depreciation and amortization expenses, and excludes discontinued
operations. We believe EBITDA provides additional information for
determining our ability to meet future debt service requirements. EBITDA
should not be construed as a substitute for income from operations, net
income or cash flow from operating activities (all determined in accordance
with GAAP) for the purpose of analyzing our operating performance,
financial position and cash flow as EBITDA is not defined by generally
accepted accounting principles. We have presented EBITDA, however, because
it is commonly used by certain investors to analyze and compare companies
on the basis of operating performance and to determine a company's ability
to service and/or incur debt. Our computation of EBITDA may not be
comparable to similar titled measures of other companies. EBITDA is
calculated as follows:
FISCAL YEAR ENDED
-----------------------------------------------
JAN. 29, JAN. 31, FEB. 1, FEB. 2, FEB. 3,
2005 2004 2003 2002 2001
------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
Income from operations ................. $56,075 $57,372 $58,960 $53,949 $70,219
Add: Depreciation and amortization ..... 17,319 17,026 16,827 19,348 16,878
------- ------- ------- ------- -------
EBITDA ................................. $73,394 $74,398 $75,787 $73,297 $87,097
======= ======= ======= ======= =======
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
----------------------------------------------------------------------
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations ("MD&A") is provided as a supplement to the
accompanying consolidated financial statements and notes thereto contained in
Item 8 of this report. This MD&A is organized as follows:
o EXECUTIVE OVERVIEW - This section provides a general description of
our business and a brief discussion of the opportunities, risks and
uncertainties 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.
o FORWARD-LOOKING INFORMATION AND RISK FACTORS THAT MAY AFFECT FUTURE
RESULTS - 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 Burdines departments have been accounted for as a discontinued
operation, and, unless otherwise indicated, the following discussion relates to
our continuing operations.
EXECUTIVE OVERVIEW
- ------------------
OUR BUSINESS
We are one of the leading retailers of fine jewelry in the United States
and operate licensed 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 $201 per item. As
of January 29, 2005, we operated 962 locations in 16 host store groups, in 46
states and the District of Columbia.
Our primary focus is to offer 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
typically required of the traditional retail jewelry business, host stores
improve their return on investment and increase their profitability. As a
licensee, 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. In recent
years, on average, approximately 50% of our merchandise has been carried on
17
consignment, which reduces our inventory exposure to changing fashion trends.
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 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 net sales growth (current year total net sales minus prior year
total net sales divided by prior year total net sales equals
percentage change) which indicates, among other things, the success of
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. Key components of income from operations
which management focuses on include monitoring gross margin levels as
well as continued emphasis on leveraging our SG&A.
2004 HIGHLIGHTS
During 2004, we successfully executed our marketing and merchandising
strategy, as evidenced by our 2.7% growth in comparable department sales,
achieved strong operating cash flow and increased profitability. Over the past
decade, we have experienced comparable store sales increases (in nine out of ten
years) and we have consistently outperformed our host store groups with respect
to these increases. We attribute our success to an experienced and stable
management team, a well-trained and highly motivated sales force, an expert
jewelry merchandising team, unique vendor relationships and an established
customer base. Also contributing to our success are our merchandising and
inventory control system and point-of-sale system for our departments, which
provide the foundation for improved productivity. Total sales were $923.6
million in 2004 compared to $902.4 million in 2003, an increase of 2.3%. Gross
margin increased by $7.3 million in 2004 compared to 2003, and as a percentage
of sales, gross margin decreased by 0.4% from 51.2% to 50.8%. Although SG&A
increased by $8.7 million, as a percentage of sales, SG&A remained flat at
42.9%.
During 2004, we effectively managed our inventories and implemented
appropriate expense controls. We ended 2004 with $62.0 million of cash compared
to $89.5 million at the end of 2003. This decrease related primarily to the
reduction of long-term debt as a result of the refinancing of the Senior Notes
and the Senior Debentures as well as fees and expenses related to the
transaction. Additionally, borrowings under the Revolving Credit Agreement were
reduced to zero by the end of December 2004. The average outstanding balance
increased to $50.6 million as compared to $42.7 million in the prior year,
primarily as a result of the refinancing of the Senior Notes and the Senior
Debentures. These transactions, together with the issuance of the New Senior
Notes, were undertaken to decrease our overall interest rate, extend our debt
maturities and decrease total long-term debt as well as simplify our capital
structure by eliminating debt at the parent company level. Lastly, maximum
outstanding borrowings during 2004 peaked at $99.8 million, at which point the
available borrowings under the Revolving Credit Agreement were an additional
$113.5 million.
OPPORTUNITIES
We believe that current trends in jewelry retailing provide a significant
opportunity for our growth. Consumers spent approximately $57.0 billion on
jewelry (including both fine jewelry and costume jewelry) in the United States
in calendar year 2004, an increase of approximately $21.0 billion over 1994,
according to the United States Department of Commerce. In the department store
sector in which we
18
operate, consumers spent an estimated $4.1 billion on fine jewelry in calendar
year 2003. 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.
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.
On March 1, 2005, the Holding Company announced that it is in advanced
discussions regarding a possible acquisition of Carlyle. Carlyle is a
privately-owned regional chain, located primarily in the southeastern United
States, with 32 jewelry stores and annual sales of approximately $80.0 million.
Finlay is presently engaged in its due diligence review of Carlyle.
In 2004, the Company tested moissanite merchandise (moissanite is a
lab-created stone with greater brilliance and luster than a diamond) in certain
departments. This new category of merchandise will be expanded to additional
departments in 2005 and is estimated to generate sales of $10-$15 million.
Additional growth opportunities exist with respect to opening departments
within existing host store groups that do not currently operate jewelry
departments. Such opportunities exist within Dillard's and Belk's. During 2003
and 2004, we added a total of 24 new departments in Dillard's and Belks and plan
to add a total of seven departments within these host store groups during 2005.
In November 2003, we began a relationship with SmartBargains to provide
jewelry via its internet site and absorbed this e-business fulfillment into our
distribution center. Sales generated via this internet business during 2004
totaled approximately $8.0 million. We will continue to seek to identify
complementary businesses to leverage our core competencies in the jewelry
industry.
We continue to seek growth opportunities and plan to continue to pursue the
following key initiatives to further increase sales and earnings:
o Increase comparable department sales;
o Add departments within existing host store groups;
o Expansion of our most productive departments;
o Identify and acquire new businesses;
o Open new channels of distribution;
o Introduction of new fashion trends;
o Add new host store relationships;
o Continue to raise customer service standards;
o Strengthen selling teams through training programs;
o Continue to improve operating leverage; and
o De-leverage the balance sheet.
19
See "Business-Growth Strategy" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
RISKS AND UNCERTAINTIES
We achieved sustained growth during 2004, however, we have faced certain
challenges as well, including:
o Host store consolidation; and
o Dependence on or loss of certain host store relationships.
During 2004, approximately 59% (including Marshall Field's for the 2004
fiscal year) and 19% of our sales were generated by departments operated in
store groups owned by May and Federated, respectively. We have operated
departments with May since 1948 and with Federated since 1983. We believe that
our relationships with these host stores are excellent. Nevertheless, a decision
by either company, or certain of our host store groups, to terminate existing
relationships, to assume the operation of those departments themselves, or to
close significant number of stores would have a material adverse effect on our
business and financial condition.
On February 28, 2005, Federated and May announced that they have entered
into a merger agreement whereby Federated would acquire May. The transaction is
expected to close in the third quarter of 2005. The completion of the merger is
contingent upon regulatory review and approval by the shareholders of both
companies. Finlay's license agreements with May are terminable as follows:
Robinsons-May/Meier & Frank, Filene's/Kaufmann's and Famous Barr/L.S.
Ayres/Jones on January 28, 2006, Foley's, Hecht's/Strawbridge's and Lord &
Taylor on February 3, 2007 and Marshall Field's on April 2, 2008. Finlay's
license agreements with Federated are terminable as follows:
Rich's-Macy's/Lazarus-Macy's/Goldsmith's-Macy's and Bon-Macy's on January 28,
2006 and Bloomingdale's on February 3, 2007. We cannot anticipate the impact of
the proposed transaction on our future results of operations and there is no
assurance that we will not be adversely impacted.
As a result of Federated's decision not to renew our license agreement in
its Burdines department store division in 2003 due to the consolidation of the
Burdines and Macy's fine jewelry departments, we closed 46 Burdines departments
in January 2004. These departments generated approximately $55 million in
revenue during 2003.
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 18 departments in 2004,
which generated approximately $10.6 million in sales. Through January 29, 2005,
a total of 27 stores have closed.
20
RESULTS OF OPERATIONS
The following table sets forth operating results as a percentage of sales
for the periods indicated. The discussion that follows should be read in
conjunction with the following table:
FISCAL YEAR ENDED
---------------------------------
JAN. 29, JAN. 31, FEB. 1,
2005 2004 2003
-------- -------- --------
STATEMENT OF OPERATIONS DATA:
Sales ...................................................... 100.0% 100.0% 100.0%
Cost of sales .............................................. 49.2 48.8 48.4
-------- -------- --------
Gross margin ............................................. 50.8 51.2 51.6
Selling, general and administrative expenses ............... 42.9 42.9 43.1
Credit associated with the closure of Sonab ................ -- -- (0.1)
Depreciation and amortization .............................. 1.8 1.9 1.9
-------- -------- --------
Income from operations ..................................... 6.1 6.4 6.7
Interest expense, net ...................................... 2.2 1.9 2.0
Other expense - debt extinguishment costs (1) .............. 0.7 -- --
-------- -------- --------
Income from continuing operations before income
taxes and cumulative effect of accounting change ......... 3.2 4.5 4.7
Provision for income taxes ................................. 1.1 1.8 1.8
-------- -------- --------
Income from continuing operations before
cumulative effect of accounting change ................... 2.1 2.7 2.9
Discontinued operations, net of tax (2) .................... -- (1.3) 0.4
Cumulative effect of accounting change,
net of tax (3) ........................................... -- -- (1.9)
-------- -------- --------
Net income ................................................. 2.1% 1.4% 1.4%
======== ======== ========
- ----------
(1) See Note 5 to "Selected Consolidated Financial Data".
(2) See Note 2 to "Selected Consolidated Financial Data".
(3) See Note 7 to "Selected Consolidated Financial Data".
21
2004 COMPARED WITH 2003
SALES. Sales increased $21.2 million, or 2.3%, in 2004 compared to 2003.
The increase in sales is due primarily to the 2.7% increase in comparable
department sales. Additionally, total sales increased as a result of the net
effect and timing of new department openings and closings. We attribute the
increase in sales primarily to our 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; (iii) using host store groups' proprietary
customer lists for targeted marketing; and (iv) positioning our departments as a
"destination location" for fine jewelry.
Our major merchandise categories include diamonds, gold, gemstones, watches
and designer jewelry. Diamond sales increased $11.4 million, or 4.9%, in 2004
compared to 2003 due primarily to the increase in consumer demand for diamond
fashion assortments, including categories such as solitare and bridal jewelry,
diamond stud earring assortments and three-stone jewelry. Designer jewelry sales
increased $10.6 million, or 24.9%, in 2004 compared to 2003. Sales in all other
categories remained relatively flat in 2004 compared to 2003.
During 2004, we opened 28 departments, within existing store groups, and
closed 38 departments. The openings were comprised of the following:
NUMBER OF
STORE GROUP DEPARTMENTS
----------------------------------- -----------
May........................ 9
Dillard's.................. 11
Federated.................. 3
Saks....................... 1
Other...................... 4
----
Total............. 28
====
The closings were comprised of the following:
NUMBER OF
STORE GROUP DEPARTMENTS REASON
----------------------------------- ----------- --------------------------------------------------
Lord & Taylor.............. 17 May closed these less profitable locations.
Other...................... 21 Department closings within existing store groups.
----
Total............ 38
====
GROSS MARGIN. Gross margin increased by $7.3 million in 2004 compared to
2003, and as percentage of sales, gross margin decreased by 0.4%. The components
of this 0.4% net decrease in gross margin are as follows:
COMPONENT % REASON
----------------------------------- ----------- --------------------------------------------------
Merchandise cost of sales......... (0.7)% Increase in merchandise cost of sales is due to our
continued efforts to increase market penetration
and market share through our pricing strategy, the
mix of sales with increased sales in the diamond,
designer and clearance categories, which have lower
margins than other categories as well as the
increased price of gold.
LIFO ............................. 0.3% Net decrease in the LIFO provision from $4.5
million in the 2003 period to $2.1 million in the
2004 period. As discussed below, we changed our
method of valuing inventory for LIFO purposes.
----
Total ............... (0.4)%
====
22
During the third quarter of 2004, we changed our method of determining
price indices used in the valuation of LIFO inventories. Prior to the third
quarter of 2004, we determined our LIFO inventory value by utilizing selected
producer price indices published for jewelry and watches by the Bureau of Labor
Statistics ("BLS"). During the third quarter of 2004, we began applying
internally developed indices that we believe more accurately measure inflation
or deflation in the components of our merchandise and our merchandise mix than
the BLS producer price indices. Additionally, we believe that this accounting
change is an alternative accounting method that is preferable under the
circumstances described above. As a result of this change in accounting method,
we recorded a LIFO charge of approximately $2.1 million for the year ended
January 29, 2005. Using the BLS producer price indices, the LIFO charge for the
year ended January 29, 2005 would have been $8.0 million. Had we not changed our
method of determining price indices, the net income under the former LIFO method
for the year ended January 29, 2005 would have been approximately $15.9 million.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The components of SG&A
include payroll expense, license fees, net advertising expenditures and other
field and administrative expenses. SG&A increased $8.7 million, or 2.2%. As a
percentage of sales, SG&A remained flat at 42.9%.
CREDIT ASSOCIATED WITH THE CLOSURE OF SONAB. In 2004, we revised our
estimate of closure expenses to reflect our remaining liability associated with
the closure of Sonab and, as a result, recorded a credit of $0.4 million.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased $0.3
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 $0.5 million and $0.4 million associated with the
Lord & Taylor store closings, were recorded in 2004 and 2003, respectively.
INTEREST EXPENSE, NET. Interest expense increased by $3.6 million primarily
due to an increase in average borrowings ($231.9 million for 2004 compared to
$192.7 million for 2003) as a result of the refinancing of the Senior Notes. The
weighted average interest rate was approximately 7.4% for 2004 compared to 7.3%
for 2003.
OTHER EXPENSE - DEBT EXTINGUISHMENT COSTS. Other expense - debt
extinguishment costs includes $4.4 million for redemption premiums paid on the
Senior Notes, $1.3 million to write-off deferred financing costs related to the
refinancing of the Senior Notes and $0.3 million for other expenses.
PROVISION FOR INCOME TAXES. The income tax provision for 2004 and 2003
reflects effective tax rates of 34.9% and 39.6%, respectively. The income tax
provision for 2004 includes a benefit of approximately $1.0 million associated
with the reversal of certain income tax accruals which were no longer required.
Additionally, the tax provision for 2004 includes a benefit of approximately
$0.6 million associated with tax refunds related to Sonab.
NET INCOME. Net income of $19.5 million for 2004 represents an increase of
$6.2 million as compared to net income of $13.2 million in 2003 as a result of
the factors discussed above.
2003 COMPARED WITH 2002
SALES. Sales increased $25.1 million, or 2.9%, in 2003 compared to 2002.
The increase in sales is due primarily to the 2.3% increase in comparable
department sales. Additionally, total sales increased as a result of the net
effect and timing of new department openings and closings. We attribute the
increase in sales primarily to our 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 a
"destination location" for fine jewelry.
23
Our major merchandise categories include diamonds, gold, gemstones, watches
and designer jewelry. Diamond sales increased $14.8 million, or 6.8%, in 2003
compared to 2002 due primarily to the increase in consumer demand for diamond
fashion assortments, including emerging merchandise categories such as
three-stone jewelry. Designer jewelry sales increased $9.6 million, or 29.1%, in
2003 compared to 2002. Sales in all other categories remained relatively flat in
2003 compared to 2002.
During 2003, we opened 32 departments, within existing store groups, and
closed 71 departments. The openings were comprised of the following:
NUMBER OF
STORE GROUP DEPARTMENTS
----------------------------------- -----------
May........................ 10
Dillard's.................. 9
Federated.................. 5
Saks....................... 3
Other...................... 5
----
Total............. 32
====
The closings were comprised of the following:
NUMBER OF
STORE GROUP DEPARTMENTS REASON
----------------------------------- ----------- --------------------------------------------------
Burdines................... 46 Federated did not renew our license agreement.
Lord & Taylor.............. 7 May closed these less profitable locations.
Other...................... 18 Department closings within existing store groups.
----
Total............ 71
====
GROSS MARGIN. Gross margin increased by $9.4 million in 2003 compared to
2002, and as percentage of sales, gross margin decreased by 0.4%. The components
of this 0.4% net decrease in gross margin are as follows:
COMPONENT % REASON
----------------------------------- ----------- --------------------------------------------------
Merchandise cost of sales......... (0.6%) Increase in merchandise cost of sales is due to our
continued efforts to increase market penetration
and market share through our pricing strategy and
the impact of higher gold prices.
LIFO ............................. (0.2%) Increase in LIFO provision from $2.2 million to
$4.5 million.
Shortage ......................... 0.4% Decrease in shortage is due primarily to favorable
physical inventory results.
------
Total ............... (0.4%)
======
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The components of SG&A
include payroll expense, license fees, net advertising expenditures and other
field and administrative expenses. SG&A increased $9.4 million, or 2.5%. As a
percentage of sales, SG&A decreased to 42.9% from 43.1%. The components of this
0.2% net decrease in SG&A are as follows:
COMPONENT % REASON
----------------------------------- ----------- --------------------------------------------------
Net advertising expenditures...... 0.2% Decrease in net advertising expenditures is due
primarily to increased vendor support.
Payroll expense .................. (0.1%) Favorably impacted by the leveraging of payroll
expense, offset by an increase in medical expenses
as 2002 included a $1.8 million benefit. This $1.8
million benefit related to favorable claims
experience following a change in medical insurance
carriers.
Other field expenses.............. 0.1% Decrease in other field expenses is due primarily
to the favorable leveraging of these expenses.
-----
Total ............. 0.2%
=====
24
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased $0.2
million reflecting additional depreciation and amortization as a result of
capital expenditures for the most recent twelve months, offset by the effect of
certain assets becoming fully depreciated. In addition, accelerated depreciation
costs totaling approximately $0.4 million, associated with the Lord & Taylor
store closings, were recorded in the period.
INTEREST EXPENSE, NET. Interest expense decreased by $1.1 million primarily
due to a decrease in average borrowings ($192.7 million for 2003 compared to
$211.2 million for 2002). The weighted average interest rate was approximately
7.3% for 2003 compared to 7.1% for 2002.
PROVISION FOR INCOME TAXES. The income tax provision for 2003 and 2002
reflects effective tax rates of 39.3% and 38.9%, respectively. The income tax
provision in 2002 was reduced for certain income tax accruals which were no
longer required.
DISCONTINUED OPERATIONS. Discontinued operations includes the results of
operations of the Burdines department store division. The net loss from
discontinued operations for 2003 was $11.5 million compared to the net income
from discontinued operations of $3.8 million in 2002. The loss in 2003 included
$1.2 million of pre-tax charges associated with the accelerated depreciation of
fixed assets and severance, as well as a charge of $13.8 million for the
write-down of goodwill resulting from the Burdines department closings.
NET INCOME. Net income of $13.2 million for 2003 represents an increase of
$1.4 million as compared to net income of $11.8 million in 2002 as a result of
the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Information about our financial position is presented in the following
table:
JANUARY 29, JANUARY 31,
2005 2004
----------- -----------
(IN THOUSANDS)
--------------
Cash and cash equivalents......... $ 61,957 $ 89,481
Working capital................... 229,886 197,297
Long-term debt.................... 200,000 150,000
Stockholder's equity.............. 164,857 185,100
Our primary capital requirements are for funding working capital for new
departments and growth of existing departments, as well as debt service
obligations and license fees to host store groups, and, to a lesser extent,
capital expenditures for opening new departments, renovating existing
departments and information technology investments. For 2004 and 2003, capital
expenditures totaled $12.7 million and $12.9 million, respectively. Total
capital expenditures for 2005 are estimated to be approximately $10 to $12
million, excluding any impact from the possible Carlyle acquisition. 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.
25
Cash flows provided from (used in) operating, investing and financing
activities for the fiscal years ended January 29, 2005, January 31, 2004 and
February 1, 2003 were as follows:
FISCAL YEARS ENDED
-----------------------------------------
JANUARY 29, JANUARY 31, FEBRUARY 1,
2005 2004 2003
----------- ----------- -----------
(IN THOUSANDS)
Operating Activities ............................. $ (14,172) $ 48,279 $ 52,291
Investing Activities ............................. (12,667) (12,934) (15,750)
Financing Activities ............................. (685) (14,349) (17,278)
----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents ............................... $ (27,524) $ 20,996 $ 19,263
=========== =========== ===========
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; and
o Strategic acquisitions.
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, license fees and payments of interest
and taxes. Net cash flows used in operations were $14.2 million for 2004,
consisting principally of the payment of an intercompany tax liability to the
Holding Company totaling $43.4 million as well as a decrease in accounts payable
due to lower inventory receipts and lower consignment inventory sales.
Our operations substantially preclude customer receivables as our license
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 $229.9 million at January 29, 2005, an increase
of $32.6 million from January 31, 2004. The increase resulted primarily from the
impact of 2004's net income (exclusive of depreciation and amortization), offset
by capital expenditures, payment of dividends to the Holding Company and the
reduction of cash to pay down long-term debt associated with the refinancing of
the Senior Notes and the Senior Debentures.
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 license 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 $5.6
million, or 2.1%, as compared to January 31, 2004 partially as a result of
further investments in the diamond and designer categories.
26
INVESTING ACTIVITIES
Net cash used in investing activities, consisting of payments for capital
expenditures, was $12.7 million, $12.9 million and $15.8 million in 2004, 2003
and 2002, respectively. Capital expenditures in 2004 and 2003 related primarily
to expenditures for new department openings and renovations.
FINANCING ACTIVITIES
Payments on debt and the issuing of dividends to the Holding Company have
been our primary financing activities. Additionally, during 2004, we refinanced
our long-term debt. Net cash used in financing activities was $0.7 million in
2004, consisting principally of proceeds from the issuance of the New Senior
Notes, offset by the purchase and redemption of the outstanding Senior Notes,
payments of dividends to the Holding Company and capitalized financing costs
related to the New Senior Notes. Net cash used in financing activities was $14.3
million and $17.3 million in 2003 and 2002, respectively.
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 4.0% and 3.4% for 2004 and 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 at January 29, 2005 and January 31, 2004 were
zero. The average amounts outstanding under the Revolving Credit Agreement
during 2004 and 2003 were $50.6 million and $42.7 million, respectively. The
maximum amount outstanding during 2004 was $99.8 million, at which point the
available borrowings were an additional $113.5 million.
On May 7, 2004, we and the Holding Company each commenced an offer to
purchase for cash any and all of our Senior Notes and the Holding Company's
Senior Debentures, respectively. In conjunction with the tender offers, we and
the Holding Company each solicited consents to effect certain proposed
amendments to the indentures governing the Senior Notes and the Senior
Debentures. On May 20, 2004, we and the Holding Company announced that holders
of approximately 98% and 79% of the outstanding Senior Notes and the outstanding
Senior Debentures, respectively, tendered their securities and consented to the
proposed amendments to the related indentures.
On June 3, 2004, we 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 and commenced on December 1, 2004. We used the net proceeds from the
offering of the New Senior Notes, together with drawings from our Revolving
Credit Facility, to repurchase the tendered Senior Notes and to make consent
payments and to distribute $77.3 million to the Holding Company to enable the
Holding Company to repurchase the tendered Senior Debentures and to make consent
payments. Additionally, on June 3, 2004, we and the Holding Company called for
the redemption of all of the untendered Senior Notes and Senior Debentures,
respectively, and these securities were repurchased on July 2, 2004.
The tender offers, New Senior Notes offering, and redemptions of the
outstanding Senior Notes and Senior Debentures were all undertaken to decrease
our overall interest rate, extend our debt maturities and decrease total
long-term debt as well as simplify our capital structure by eliminating debt at
the parent company level. As a result of the completion of the redemption of the
Senior Debentures, we are no longer required to provide the funds necessary to
pay the higher debt service costs associated with the Senior Debentures.
27
We incurred approximately $5.2 million in costs, including $5.0 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 $6.0 million, including $4.4 million
for redemption premiums paid on the Senior Notes, $1.3 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 September 2004, for the purpose of an exchange offer, we registered
notes with terms identical to the New Senior Notes under the Securities Act of
1933. We completed the exchange offer in the third quarter of 2004 and 100% of
the original notes were exchanged for the registered notes.
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 with respect to the New Senior Notes and amounts due
under the Revolving Credit Agreement, including payments required under the
Balance Reduction Requirement. As of January 29, 2005, our outstanding
borrowings were $200.0 million under the New Senior Notes.
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, we are a party to the Gold Consignment Agreement, which
also contains certain covenants. As of and for the year ended January 29, 2005,
we are in compliance with all of our covenants. We expect to be in compliance
with all of our covenants through 2005. 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 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, we will, for the
foreseeable future, be able to meet our debt service and anticipated working
capital obligations and to make distributions to the Holding Company sufficient
to permit the Holding Company to pay certain expenses as they come due. No
assurances, however, can be given that our current level of operating results
will continue or improve or that our income from operations will continue to be
sufficient to permit us to meet our debt service and other obligations.
Currently, our principal financing arrangements restrict the amount of annual
distributions to the Holding Company, including those required to fund stock
repurchases. The amounts required to satisfy the aggregate of our interest
expense totaled $19.6 million and $16.0 million in 2004 and 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. At January 29, 2005 and
28
January 31, 2004 $349.7 million and $364.5 million, respectively, of consignment
merchandise from approximately 300 vendors was on hand. For 2004, we had an
average balance of consignment merchandise of $365.2 million as compared to an
average balance of $364.7 million in 2003.
The following table summarizes our contractual and commercial obligations
which may have an impact on future liquidity and the availability of capital
resources, as of January 29, 2005 (dollars in thousands):
PAYMENTS DUE BY PERIOD
--------------------------------------------------------------
LESS THAN 1 - 3 3 - 5 MORE THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
- ----------------------- ---------- ---------- ---------- ---------- ----------
Long-Term Debt Obligations:
New Senior Notes (due 2012) (1) .............. $ 200,000 $ -- $ -- $ -- $ 200,000
Interest payments on New Senior Notes (1) ........ 122,833 16,750 33,500 33,500 39,083
Operating lease obligations (2) .................. 7,054 1,942 3,834 1,278 --
Revolving Credit Agreement (due 2008) (3) ........ -- -- -- -- --
Gold Consignment Agreement (expires 2005) ........ 49,802 49,802 -- -- --
Gold forward contracts ........................... 16,066 16,066 -- -- --
Letters of credit ................................ 11,690 11,440 -- 250 --
---------- ---------- ---------- ---------- ----------
Total ......................................... $ 407,445 $ 96,000 $ 37,334 $ 35,028 $ 239,083
========== ========== ========== ========== ==========
- ----------
(1) On June 3, 2004, we issued $200.0 million of New Senior Notes due 2012.
Refer to Note 5 of Notes to the Consolidated Financial Statements.
(2) Represents future minimum payments under noncancellable operating leases as
of January 29, 2005.
(3) There were no borrowings under the Revolving Credit Agreement at January
29, 2005. The average amount outstanding during 2004 was $50.6 million and
the outstanding balance as of April 8, 2005 was $22.3 million.
The operating leases included in the above table do not include contingent
rent based upon sales volume or variable costs such as maintenance, insurance
and taxes. Our open purchase orders are cancelable without penalty and are
therefore not included in the above table. There were no commercial commitments
outstanding as of January 29, 2005, other than as disclosed in the table above,
nor have we provided any third-party financial guarantees as of and for the year
ended January 29, 2005.
OFF-BALANCE SHEET ARRANGEMENTS
Our Gold Consignment Agreement enables us to receive consignment
merchandise by providing gold, or otherwise making payment, to certain vendors.
While the merchandise involved remains consigned, title to the gold content of
the merchandise transfers from the vendors to the gold consignor. The Gold
Consignment Agreement matures on July 31, 2005 and permits us 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. We are
currently in the process of extending the term of the Gold Consignment
Agreement. At January 29, 2005, amounts outstanding under the Gold Consignment
Agreement totaled 116,687 fine troy ounces, valued at $49.8 million. The average
amount outstanding under the Gold Consignment Agreement was $48.9 million in
2004. In the event this agreement is terminated, we 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 us to comply with certain
covenants, including restrictions on the incurrence of certain indebtedness, the
creation of liens, engaging in transactions with affiliates and limitations on
the payment of dividends. In addition, the Gold Consignment Agreement also
contains various financial covenants, including minimum earnings and fixed
charge coverage ratio requirements and certain maximum debt limitations. At
January 29, 2005, we were in compliance with all of our 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
29
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
In November 2004, we entered into a new employment agreement with a senior
executive. The new employment agreement has a term of four years commencing on
January 30, 2005 and ending on January 31, 2009, unless earlier terminated, in
accordance with the provisions of the employment agreement. The new employment
agreement provides an annual salary level of approximately $1.0 million as well
as incentive compensation based on meeting specific financial goals, which are
not yet determinable.
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 January 29, 2005, we had several open
positions in gold forward contracts totaling 37,000 fine troy ounces, to
purchase gold for $16.1 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 licensed jewelry department
subsidiary, sold the majority of its assets for approximately $9.9 million. As
of January 29, 2005, our exit plan has been completed with the exception of
certain legal matters and we are in the process of liquidating the subsidiary.
During the fourth quarter of 2004, we revised our estimate of closure expenses
to reflect our remaining liability, and as a result, reduced our accrual by $0.4
million. To date, we have charged a total of $26.4 million against our revised
estimate of $26.8 million. We do not believe future operating results or
liquidity will be materially impacted by any remaining payments.
SEASONALITY
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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 accounted for an
average of approximately 42% of our sales and approximately 90% of our income
from operations for 2004 and 2003. 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. See Note 13 of Notes to Consolidated Financial Statements.
The following table summarizes the quarterly financial data for 2004 and
2003:
FISCAL QUARTER
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FIRST (a) SECOND (a) THIRD FOURTH
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(DOLLARS IN THOUSANDS)
(UNAUDITED)
2004:
Sales .............................. $ 187,572 $ 188,638 $ 166,841 $ 380,555
Gross margin ....................... 95,729 96,164 84,612 192,710
Income (loss) from operations ...... 3,159 4,504 (2,315) 50,727
Net income (loss) .................. (530) (3,330)(b) (4,828) 28,175
2003:
Sales .............................. $ 175,427 $ 182,229 $ 165,784 $ 378,976
Gross margin ....................... 90,766 92,796 84,717 193,620
Income (loss) from operations ...... 2,669 4,502 (62) 50,263
Net income (loss) .................. (234) 645 (2,713) 15,546(c)
30
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(a) The thirteen week periods ended May 1, 2004 and July 31, 2004 have been
restated to reflect the change in our method of determining LIFO
inventories. Refer to Note 3 to Notes to Consolidated Financial Statements.
(b) The net loss includes debt extinguishment costs of $6.0 million related to
the refinancing of the Senior Notes in the second quarter of 2004. Refer to
Note 5 to Notes to Consolidated Financial Statements.
(c) Net income includes the write-down of goodwill of $13.8 million in the
fourth quarter of 2003. Refer to Note 11 to Notes to Consolidated Financial
Statements.
INFLATION
The effect of inflation on our results of operations has not been material
in the periods discussed.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
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The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires the appropriate
application of certain accounting policies, many of which require us to make
estimates and assumptions about future events and their impact on amounts
reported in our financial statements and related notes. We believe the
application of our accounting policies, and the estimates inherently required
therein, are reasonable. These accounting policies and estimates are constantly
re-evaluated, and adjustments are made when facts and circumstances dictate a
change. However, since future events and their impact cannot be determined with
certainty, actual results may differ from our estimates, and such differences
could be material to the consolidated financial statements. Historically, we
have found our application of accounting policies to be appropriate, and actual
results have not differed materially from those determined using necessary
estimates. A summary of our significant accounting policies and a description of
accounting policies that we believe are most critical may be found in Note 2 to
the Consolidated Financial Statements.
MERCHANDISE INVENTORIES
We value our inventories at the lower of cost or market. The cost is
determined by the LIFO method utilizing an internally generated index. 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 flows from th