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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
- THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended October 30, 2004
----------------
or
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _________ to __________
Commission File Number: 33-59380
FINLAY FINE JEWELRY CORPORATION
-------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3287757
- --------------------------------- ------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
529 Fifth Avenue, New York, NY 10017
-------------------------------- ---------
(Address of principal executive offices) (zip code)
(212) 808-2800
--------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X* No
------ ------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
------ ------
As of December 3, 2004, there were 1,000 shares of common stock, par value $.01
per share, of the registrant outstanding. As of such date, all shares of common
stock were owned by the registrant's parent, Finlay Enterprises, Inc., a
Delaware corporation.
*The registrant is not subject to the filing requirements of Section 13 or 15(d)
of the Exchange Act and is voluntarily filing this Quarterly Report on Form
10-Q.
FINLAY FINE JEWELRY CORPORATION
FORM 10-Q
QUARTERLY PERIOD ENDED OCTOBER 30, 2004
INDEX
PART I - FINANCIAL INFORMATION
PAGE(S)
-------
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Statements of Operations for the thirteen weeks and
thirty-nine weeks ended October 30, 2004 and November 1, 2003.......................1
Consolidated Balance Sheets as of October 30, 2004 and
January 31, 2004....................................................................3
Consolidated Statements of Changes in Stockholder's Equity for the
year ended January 31, 2004 and the thirty-nine weeks ended
October 30, 2004....................................................................4
Consolidated Statements of Cash Flows for the thirteen weeks and
thirty-nine weeks ended October 30, 2004 and November 1, 2003.......................5
Notes to Consolidated Financial Statements..........................................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......................................17
Item 3. Quantitative and Qualitative Disclosures about Market Risk.........................33
Item 4. Controls and Procedures............................................................33
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........................34
Item 6. Exhibits...........................................................................34
SIGNATURES....................................................................................................36
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
THIRTEEN WEEKS ENDED
------------------------------------
OCTOBER 30, NOVEMBER 1,
2004 2003
--------------- ---------------
Sales.................................................................... $ 166,841 $ 165,784
Cost of sales............................................................ 82,229 81,067
--------------- ---------------
Gross margin......................................................... 84,612 84,717
Selling, general and administrative expenses............................. 82,629 80,426
Depreciation and amortization............................................ 4,298 4,353
--------------- ---------------
Loss from operations................................................. (2,315) (62)
Interest expense, net.................................................... 5,598 4,184
--------------- ---------------
Loss from continuing operations before income taxes.................. (7,913) (4,246)
Benefit for income taxes................................................. (3,085) (1,656)
--------------- ---------------
Loss from continuing operations...................................... (4,828) (2,590)
Discontinued operations, net of tax...................................... - (123)
--------------- ---------------
Net loss ............................................................ $ (4,828) $ (2,713)
=============== ===============
The accompanying notes are an integral part of these consolidated
financial statements.
1
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
THIRTY-NINE WEEKS ENDED
------------------------------------
OCTOBER 30, NOVEMBER 1,
2004 2003
--------------- ---------------
Sales.................................................................... $ 543,051 $ 523,440
Cost of sales............................................................ 266,546 255,161
--------------- ---------------
Gross margin......................................................... 276,505 268,279
Selling, general and administrative expenses............................. 258,096 248,452
Depreciation and amortization............................................ 13,061 12,718
--------------- ---------------
Income from operations............................................... 5,348 7,109
Interest expense, net.................................................... 14,651 12,417
Other expense - debt extinguishment costs................................ 5,962 -
--------------- ---------------
Loss from continuing operations before income taxes ................. (15,265) (5,308)
Benefit for income taxes................................................. (6,577) (2,068)
--------------- ---------------
Loss from continuing operations...................................... (8,688) (3,240)
Discontinued operations, net of tax...................................... - 938
--------------- ---------------
Net loss ............................................................ $ (8,688) $ (2,302)
=============== ===============
The accompanying notes are an integral part of these
consolidated financial statements.
2
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
OCTOBER 30, JANUARY 31,
2004 2004
------------- --------------
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 1,713 $ 89,481
Accounts receivable - department stores...................................... 37,065 21,602
Other receivables............................................................ 54,972 38,457
Merchandise inventories...................................................... 305,282 272,948
Prepaid expenses and other................................................... 5,101 2,596
Deferred income taxes....................................................... - 6,564
------------- --------------
Total current assets...................................................... 404,133 431,648
------------- --------------
Fixed assets:
Building, equipment, fixtures and leasehold improvements..................... 126,396 117,631
Less - accumulated depreciation and amortization............................. 61,310 51,506
------------- --------------
Fixed assets, net......................................................... 65,086 66,125
------------- --------------
Deferred charges and other assets, net......................................... 17,912 17,263
Goodwill....................................................................... 77,288 77,288
------------- --------------
Total assets.............................................................. $ 564,419 $ 592,324
============= ==============
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Short-term borrowings........................................................ $ 78,497 $ -
Accounts payable - trade..................................................... 54,094 122,976
Accrued liabilities:
Accrued salaries and benefits............................................. 15,793 18,756
Accrued miscellaneous taxes............................................... 5,883 7,179
Accrued interest.......................................................... 7,466 3,615
Deferred income........................................................... 6,569 9,515
Deferred income taxes..................................................... 6,635 -
Other..................................................................... 16,300 15,432
Income taxes payable......................................................... 11,730 49,320
Due to parent................................................................ 1,384 8,359
------------- --------------
Total current liabilities................................................. 204,351 235,152
Long-term debt................................................................. 200,000 150,000
Deferred income taxes.......................................................... 22,548 21,992
Other non-current liabilities.................................................. 67 80
------------- --------------
Total liabilities......................................................... 426,966 407,224
------------- --------------
Stockholder's equity:
Common Stock, par value $.01 per share; authorized 5,000 shares;
issued and outstanding 1,000 shares....................................... - -
Additional paid-in capital .................................................. 82,975 82,975
Retained earnings............................................................ 53,819 102,210
Accumulated other comprehensive income (loss)................................ 659 (85)
------------- --------------
Total stockholder's equity................................................ 137,453 185,100
------------- --------------
Total liabilities and stockholder's equity................................ $ 564,419 $ 592,324
============= ==============
The accompanying notes are an integral part of these
consolidated financial statements.
3
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ACCUMULATED
COMMON STOCK OTHER
-------------------- ADDITIONAL COMPREHENSIVE TOTAL
NUMBER PAID-IN RETAINED INCOME STOCKHOLDER'S
OF SHARES AMOUNT CAPITAL EARNINGS (LOSS) EQUITY
------------ --------- ------------- ---------- -------------- -------------
Balance, February 1, 2003................. 1,000 $ - $ 82,975 $ 104,525 $ 55 $ 187,816
Net income............................ - - - 13,244 - 13,244
Change in fair value of gold
forward contracts, net of tax.... - - - - (140) (140)
Dividends on common stock ............ - - - (15,820) - (15,820)
--------- --------- ---------- ---------- ----------- -----------
Balance, January 31, 2004................. 1,000 - 82,975 102,210 (85) 185,100
Net loss.............................. - - - (8,688) - (8,688)
Change in fair value of gold
forward contracts, net of tax.... - - - - 744 744
Dividends on common stock ............ - - - (39,703) - (39,703)
--------- --------- ---------- ---------- ----------- -----------
Balance, October 30, 2004................. 1,000 $ - $ 82,975 $ 53,819 $ 659 $ 137,453
========= ========= ========== ========== =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
4
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THIRTEEN WEEKS ENDED
----------------------------
OCTOBER 30, NOVEMBER 1,
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss................................................................. $ (4,828) $ (2,713)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization............................................ 4,298 4,991
Amortization of deferred financing costs................................. 292 206
Amortization of restricted stock compensation and
restricted stock units............................................... 377 153
Deferred income tax provision............................................ 1,676 1,097
Other, net............................................................... (398) 128
Changes in operating assets and liabilities:
(Increase) decrease in accounts and other receivables................. 2,344 (9,123)
Increase in merchandise inventories................................... (24,854) (35,430)
Increase in prepaid expenses and other................................ (1,359) (249)
Increase in accounts payable and accrued liabilities.................. 11,724 24,216
Decrease in due to parent............................................. (41) (2,128)
------------- ------------
NET CASH USED IN OPERATING ACTIVITIES............................. (10,769) (18,852)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment, fixtures and leasehold improvements.............. (3,279) (2,971)
Deferred charges and other, net.......................................... - (23)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES.............................. (3,279) (2,994)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility.................................. 149,237 155,925
Principal payments on revolving credit facility.......................... (130,708) (135,151)
Capitalized financing costs.............................................. (78) -
Bank overdraft........................................................... (3,788) 640
------------ ------------
NET CASH PROVIDED FROM FINANCING ACTIVITIES..................... 14,663 21,414
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................ 615 (432)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD............................. 1,098 1,568
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD................................... $ 1,713 $ 1,136
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid.......................................................... $ 1,208 $ 739
============ ============
Income taxes paid (refunded)........................................... $ (9,426) $ 2,866
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
5
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THIRTY-NINE WEEKS ENDED
--------------------------
OCTOBER 30, NOVEMBER 1,
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss................................................................. $ (8,688) $ (2,302)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization............................................ 13,061 13,710
Amortization of deferred financing costs................................. 760 621
Amortization of restricted stock compensation and
restricted stock units............................................... 983 305
Loss on extinguishment of debt........................................... 5,962 -
Deferred income tax provision............................................ 13,755 3,021
Other, net............................................................... - 542
Changes in operating assets and liabilities:
Increase in accounts and other receivables............................ (31,978) (27,049)
Increase in merchandise inventories................................... (32,334) (36,677)
Increase in prepaid expenses and other................................ (2,505) (2,713)
Decrease in accounts payable and accrued liabilities.................. (117,032) (63,808)
Decrease in due to parent............................................. (10,817) (5,055)
------------- ------------
NET CASH USED IN OPERATING ACTIVITIES............................. (168,833) (119,405)
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment, fixtures and leasehold improvements.............. (8,914) (8,001)
------------- ------------
NET CASH USED IN INVESTING ACTIVITIES.............................. (8,914) (8,001)
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility.................................. 478,753 462,409
Principal payments on revolving credit facility.......................... (400,256) (407,863)
Proceeds from issuance of New Senior Notes............................... 200,000 -
Purchase and redemption of Senior Notes.................................. (154,647) -
Capitalized financing costs.............................................. (4,849) (431)
Bank overdraft........................................................... 8,432 9,317
Payment of dividends..................................................... (37,454) (3,375)
------------- ------------
NET CASH PROVIDED FROM FINANCING ACTIVITIES..................... 89,979 60,057
------------- ------------
DECREASE IN CASH AND CASH EQUIVALENTS........................... (87,768) (67,349)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD............................. 89,481 68,485
------------- ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD................................... $ 1,713 1,136
============= ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid.......................................................... $ 10,040 $ 8,761
============= ============
Income taxes paid (refunded)........................................... $ (6,203) $ 10,518
============= ============
The accompanying notes are an integral part of these
consolidated financial statements.
6
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF ACCOUNTING AND PRESENTATION
The accompanying unaudited consolidated financial statements of Finlay Fine
Jewelry Corporation and its wholly-owned subsidiaries ("Finlay Jewelry," the
"Registrant," "we," "us" and "our"), a wholly-owned subsidiary of Finlay
Enterprises, Inc. (the "Holding Company"), have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information. References to "Finlay" mean collectively, the
Holding Company and Finlay Jewelry. In the opinion of management, the
accompanying unaudited consolidated financial statements contain all adjustments
necessary to present fairly our financial position as of October 30, 2004, and
our results of operations and cash flows for the thirteen weeks and thirty-nine
weeks ended October 30, 2004 and November 1, 2003. Due to the seasonal nature of
the business, results for interim periods are not indicative of annual results.
The unaudited consolidated financial statements have been prepared on a basis
consistent with that of the audited consolidated financial statements as of
January 31, 2004 referred to below, except as discussed in Notes 2 and 5 below.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission (the
"Commission").
These consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto included in our
Annual Report on Form 10-K for the fiscal year ended January 31, 2004 ("Form
10-K") previously filed with the Commission.
The results of operations and related disclosures for the thirteen weeks
and thirty-nine weeks ended November 1, 2003 reflect the Burdines departments as
a discontinued operation. See Note 11 for additional information regarding
discontinued operations.
Our fiscal year ends on the Saturday closest to January 31. References to
2004, 2003, 2002 and 2001 relate to the fiscal years ending January 29, 2005,
January 31, 2004, February 1, 2003 and February 2, 2002, respectively. Each of
the fiscal years includes 52 weeks.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
MERCHANDISE INVENTORIES: Consolidated inventories are stated at the lower
of cost or market determined by the last-in, first-out ("LIFO") method. See Note
5 for information regarding our change in method of determining price indices
used in the valuation of LIFO inventories from external indices published by the
Bureau of Labor Statistics ("BLS") to an internally developed index in 2004.
Inventory is reduced for estimated obsolescence or unmarketable inventory equal
to the difference between the cost of inventory and the estimated market value
based upon assumptions about future demand and market conditions.
The cost to us of gold merchandise sold on consignment, which typically
varies with the price of gold, is not fixed until the merchandise is sold. We,
at times, enter into forward contracts based upon the anticipated sales of gold
product in order to hedge against the risk of gold price fluctuations. Such
contracts typically have durations ranging from one to nine months. At both
October 30, 2004 and January 31, 2004, we had several open positions in gold
forward contracts totaling 31,500 fine troy ounces and 25,000 fine troy ounces,
respectively, to purchase gold for $12.4 million and $10.2 million,
7
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
respectively. The fair value of gold under such contracts was $13.5 million and
$10.0 million at October 30, 2004 and January 31, 2004, respectively.
VENDOR ALLOWANCES: We receive allowances from our vendors through a variety
of programs and arrangements, including cooperative advertising. Vendor
allowances are recognized as a reduction of cost of sales upon the sale of
merchandise or selling, general and administrative expenses ("SG&A") when the
purpose for which the vendor funds were intended to be used has been fulfilled.
Accordingly, a reduction or increase in vendor allowances has an inverse impact
on cost of sales and/or SG&A.
Effective in 2002, the Financial Accounting Standards Board ("FASB")
Emerging Issues Task Force ("EITF") finalized Issue No. 02-16, "Accounting By a
Customer (Including a Reseller) for Cash Consideration Received from a Vendor"
("EITF 02-16"). EITF 02-16 addresses the accounting treatment for vendor
allowances and provides that cash consideration received from a vendor should be
presumed to be a reduction of the prices of the vendors' product and should
therefore be shown as a reduction in the purchase price of the merchandise.
Further, these allowances should be recognized as a reduction in cost of sales
when the related product is sold. To the extent that the cash consideration
represents a reimbursement of a specific, incremental and identifiable cost,
then those vendor allowances should be used to offset such costs.
As of October 30, 2004 and January 31, 2004, deferred vendor allowances
totaled (i) $14.2 million and $17.1 million, respectively, for owned
merchandise, which allowances are included as an offset to merchandise
inventories on the Consolidated Balance Sheets, and (ii) $6.6 million and $9.5
million, respectively, for merchandise received on consignment, which allowances
are included as deferred income on the Consolidated Balance Sheets.
HEDGING: Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities", as amended,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. Under SFAS No. 133, all derivatives, whether designated in
hedging relationships or not, are required to be recorded on the balance sheet
at fair value. SFAS No. 133 defines requirements for designation and
documentation of hedging relationships, as well as ongoing effectiveness
assessments, which must be met in order to qualify for hedge accounting. For a
derivative that does not qualify as a hedge, changes in fair value would be
recorded in earnings immediately.
We have designated our existing derivative instruments, consisting of gold
forward contracts, as cash flow hedges. For derivative instruments designated as
cash flow hedges, the effective portion of the change in the fair value of the
derivative is recorded in accumulated other comprehensive income, a separate
component of stockholder's equity, and is reclassified into cost of sales when
the offsetting effects of the hedged transaction impact earnings. Changes in the
fair value of the derivative attributable to hedge ineffectiveness are recorded
in earnings immediately. At October 30, 2004, the fair value of the gold forward
contracts resulted in the recognition of an asset of $1.1 million. At January
31, 2004, the fair value of the gold forward contracts resulted in the
recognition of a liability of $144,000. The amount recorded in accumulated other
comprehensive income at October 30, 2004 of $659,000, net of tax, is expected to
be reclassified into earnings through early 2005. The amount recorded in
accumulated other comprehensive loss at January 31, 2004 of $85,000, net of tax,
was reclassified into earnings in the first
8
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
quarter of 2004.
We have documented all relationships between hedging instruments and hedged
items, as well as our risk management objectives and strategy for undertaking
various hedge transactions. We have also assessed, both at the hedge's inception
and on an ongoing basis, whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in cash flows of hedged
items. We believe that the designated hedges will be highly effective.
STOCK-BASED COMPENSATION: SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" amends SFAS No. 123 "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for an
entity that voluntarily changes to the fair value method of accounting for stock
options. As permitted by SFAS No. 123, we have elected to account for stock
options using the intrinsic value method. In accordance with the provisions of
SFAS No. 148 and APB No. 25, the Holding Company has not recognized compensation
expense related to its stock options. However, deferred stock-based compensation
is amortized using the straight-line method over the vesting period. Had the
fair value method of accounting been applied to the Holding Company's stock
option plans, which requires recognition of compensation cost ratably over the
vesting period of the stock options, net loss would be as follows:
THIRTEEN WEEKS ENDED THIRTY-NINE WEEKS ENDED
----------------------------- ------------------------------
OCTOBER 30, NOVEMBER 1, OCTOBER 30, NOVEMBER 1,
2004 2003 2004 2003
------------- ------------ ------------- -------------
(IN THOUSANDS)
Reported net loss ...................................... $ (4,828) $ (2,713) $ (8,688) $ (2,302)
Add: Stock-based employee compensation expense
determined under the fair value method, net of tax. (335) (188) (859) (579)
Deduct: Stock-based employee compensation expense
included in reported net loss, net of tax.......... 254 94 619 187
------------- ------------ ------------- -------------
Pro forma net loss...................................... $ (4,909) $ (2,807) $ (8,928) $ (2,694)
============= ============ ============= =============
COMPREHENSIVE INCOME (LOSS): SFAS No. 130, "Reporting Comprehensive Income"
requires disclosure of comprehensive income, defined as the total of net income
and all other non-owner changes in equity, which are recorded directly to the
stockholder's equity section of the consolidated balance sheet and, therefore,
bypass net income. For 2004 and 2003, the only non-owner change in equity
related to the change in the fair value of our outstanding gold forward
contracts. For the thirteen weeks ended October 30, 2004 and November 1, 2003,
the comprehensive loss, calculated as the total of the net loss plus the change
in the fair value of our outstanding gold forward contracts, was $4.1 million
and $2.6 million, respectively. For the thirty-nine weeks ended October 30, 2004
and November 1, 2003, the comprehensive loss was $7.9 million and $1.7 million,
respectively.
INCOME TAXES: The income tax benefit for both the 2004 and 2003 periods
reflects an effective tax rate of 39%. During the second quarter of fiscal 2004,
a benefit of approximately $0.6 million was recorded associated with the
reversal of tax accruals no longer required. Further, during the second quarter
of 2004, net current deferred tax assets decreased by approximately $10.1
million, primarily as a result of the utilization of deferred tax assets related
to the approval from the Internal Revenue Service of a favorable change of
accounting method regarding vendor allowances.
9
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENT: In June 2004, the FASB issued an
interpretation of FASB No. 143, "Accounting for Asset Retirement Obligations".
This interpretation clarifies the scope and timing of liability recognition for
conditional asset retirement obligations under FASB No. 143, and is effective no
later than the end of our 2005 fiscal year. We have determined that this
interpretation, and the adoption of FASB No. 143, will not have a material
impact on our consolidated financial statements.
NOTE 3 - DESCRIPTION OF BUSINESS
We are a retailer of fine jewelry products and operate leased fine jewelry
departments in department stores throughout the United States. The fourth
quarter of 2003 accounted for approximately 42% of our sales and approximately
86% of our income from operations, due to the seasonality of the retail jewelry
industry. Approximately 51% of our sales in 2003 were from operations in The May
Department Stores Company ("May") and 18% in departments operated in store
groups owned by Federated Department Stores ("Federated"). Including our sales
in Marshall Fields which May recently acquired, departments operated by May
would have accounted for 60% of our sales in 2003.
NOTE 4 - SHORT AND LONG-TERM DEBT
On January 22, 2003, our revolving credit agreement with General Electric
Capital Corporation and certain other lenders was amended and restated (the
"Revolving Credit Agreement"). The Revolving Credit Agreement, which matures in
January 2008, provides us with a senior secured revolving line of credit up to
$225.0 million (the "Revolving Credit Facility"). At October 30, 2004, $78.5
million was outstanding under this facility, at which point the available
borrowings were $126.1 million. The average amounts outstanding under the
Revolving Credit Agreement were $49.4 million and $42.3 million for the
thirty-nine weeks ended October 30, 2004 and November 1, 2003, respectively. The
maximum amount outstanding for the thirty-nine weeks ended October 30, 2004 was
$99.8 million, at which point the available borrowings were an additional $113.5
million. Amounts outstanding under the Revolving Credit Agreement bear interest
at a rate equal to, at our option, (i) the prime rate plus a margin ranging from
zero to 1.0% or (ii) the adjusted Eurodollar rate plus a margin ranging from
1.0% to 2.0%, in each case depending on our financial performance. The weighted
average interest rate was 3.7% and 3.3% for the thirty-nine weeks ended October
30, 2004 and November 1, 2003, respectively.
On May 7, 2004, we and the Holding Company each commenced an offer to
purchase for cash any and all of our 8-3/8% Senior Notes, due May 1, 2008,
having an aggregate principal amount of $150.0 million (the "Senior Notes") and
the Holding Company's 9% Senior Debentures, due May 1, 2008, having an aggregate
principal amount of $75.0 million (the "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 8-3/8% Senior Notes, due June 1,
2012, having an aggregate principal amount of $200.0 million (the "New Senior
Notes"). Interest on the New Senior Notes is payable semi-annually on June 1 and
December 1 of each year, commencing on December 1,
10
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - SHORT AND LONG-TERM DEBT (CONTINUED)
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 it 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.
We incurred approximately $5.1 million in costs, including $4.9 million
associated with the sale of the New Senior Notes, which have been deferred and
are being amortized over the term of the New Senior Notes. In June 2004, we
recorded pre-tax charges of approximately $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 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.
The New Senior Notes are unsecured senior obligations and rank equally in
right of payment with all of our existing and future unsubordinated indebtedness
and senior to any of our future indebtedness that is expressly subordinated to
the New Senior Notes. The New Senior Notes are effectively subordinated to our
secured indebtedness, including obligations under our Revolving Credit Agreement
and our Gold Consignment Agreement (as defined herein), to the extent of the
value of the assets securing such indebtedness, and effectively subordinated to
the indebtedness and other liabilities (including trade payables) of our
subsidiaries. We may redeem the New Senior Notes, in whole or in part, at any
time on or after June 1, 2008 at specified redemption prices, plus accrued and
unpaid interest, if any, to the date of the redemption. In addition, before June
1, 2007, we may redeem up to 35% of the aggregate principal amount of the New
Senior Notes with the net proceeds of certain equity offerings at 108.375% of
the principal amount thereof, plus accrued interest to the redemption date. Upon
certain change of control events, each holder of the New Senior Notes may
require us to purchase all or a portion of such holder's New Senior Notes at a
purchase price equal to 101% of the principal amount thereof, plus accrued
interest to the purchase date.
The indenture governing the New Senior Notes contains restrictions relating
to, among other things, the payment of dividends, redemptions or repurchases of
capital stock, the incurrence of additional indebtedness, the making of certain
investments, the creation of certain liens, the sale of certain assets, entering
into transactions with affiliates, engaging in mergers and consolidations and
the transfer of all or substantially all assets.
11
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - MERCHANDISE INVENTORIES
Merchandise inventories consisted of the following:
OCTOBER 30, JANUARY 31,
2004 2004
---------------- ------------------
(IN THOUSANDS)
Jewelry goods - rings, watches and other fine jewelry
(first-in, first-out ("FIFO") basis)......................... $ 322,752 $ 289,546
Less: Excess of FIFO cost over LIFO inventory value.............. 17,470 16,598
---------------- ------------------
$ 305,282 $ 272,948
================ ==================
In accordance with EITF 02-16, the FIFO basis of merchandise inventories
have been reduced by $14.2 million and $17.1 million at October 30, 2004 and
January 31, 2004, respectively, to reflect the vendor allowances as a reduction
in the cost of merchandise.
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 fiscal 2004, we determined our LIFO inventory value by utilizing
selected producer price indices published for jewelry and watches by the BLS.
During the third quarter of fiscal 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 principle that is preferable under the circumstances
described above. Under the new accounting method, the LIFO charge for the
thirteen and thirty-nine weeks ended October 30, 2004 was approximately $0.3
million and $0.9 million, respectively. The LIFO charge for the thirteen weeks
and the thirty-nine weeks ended October 30, 2004 would have been approximately
$1.3 million and $4.4 million, respectively, under the former LIFO method. Had
we not changed our method of determining price indices, the net loss under the
former LIFO method for the thirteen weeks and thirty-nine weeks ended October
30, 2004 would have been approximately $5.5 million and $10.8 million,
respectively. The net loss for each of the thirteen weeks ended May 1, 2004 and
July 31, 2004 have been restated to reflect this change. Under the new
accounting method, the LIFO charge for each of the thirteen weeks ended May 1,
2004 and July 31, 2004 was approximately $0.3 million, compared to $0.8 million
and $1.0 million, respectively, as previously reported. The cumulative effect of
this change on retained earnings at the beginning of 2004 and the proforma
impact of applying the new method in the periods prior to 2004 are not
determinable. Additionally, the prior year presented has not been restated to
reflect this change in accounting method. The following table presents the net
loss for the thirteen weeks ended May 1, 2004 and July 31, 2004, as restated:
THIRTEEN WEEKS ENDED
-----------------------------
MAY 1, JULY 31,
2004 2004
------------ ------------
NET LOSS:
Net loss as previously reported............................ $ (830) $ (3,759)
Impact of change in LIFO inventory valuation
method, net of tax.................................... 300 429
------------ ------------
Net loss, as restated...................................... $ (530) $ (3,330)
============ ============
Approximately $387.8 million and $364.5 million at October 30, 2004 and
January 31, 2004, respectively, of merchandise received on consignment is not
included in merchandise inventories and accounts payable-trade in the
accompanying Consolidated Balance Sheets.
12
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - MERCHANDISE INVENTORIES (CONTINUED)
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. 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. At October 30, 2004 and January 31, 2004, amounts
outstanding under the Gold Consignment Agreement totaled 115,615 and 116,835
fine troy ounces, respectively, valued at $49.2 million and $46.7 million,
respectively. For financial statement purposes, the consigned gold is not
included in merchandise inventories on the Consolidated Balance Sheets and,
therefore, no related liability has been recorded.
NOTE 6 - LEASE AGREEMENTS
We conduct substantially all of our operations as leased departments in
department stores. All of these leases, as well as rentals for office space and
equipment, are accounted for as operating leases. A substantial number of such
operating leases expire on various dates through 2008. All references herein to
leased departments refer to fine jewelry departments operated pursuant to
license agreements or other similar arrangements with host department stores.
All of the department store leases provide that, except under limited
circumstances, the title to certain of our fixed assets transfers upon
termination of the leases, and that we will receive the undepreciated value of
such fixed assets from the host store in the event such transfers occur. The
values of such fixed assets are recorded at cost at the inception of the lease
arrangement and are reflected in the accompanying Consolidated Balance Sheets.
In several cases, we are subject to limitations under our lease agreements
with host department stores which prohibit us from operating departments for
other store groups within a certain geographical radius of the host store.
The store leases provide for the payment of fees based on sales, plus, in
some instances, installment payments for fixed assets. Only minimum fees, as
represented in the table below, are guaranteed by various lease agreements.
Lease expense, included in selling, general and administrative expenses, is as
follows:
THIRTEEN WEEKS ENDED THIRTY-NINE WEEKS ENDED
--------------------------------- ---------------------------------
OCTOBER 30, NOVEMBER 1, OCTOBER 30, NOVEMBER 1,
2004 2003 2004 2003
--------------- -------------- -------------- ---------------
(IN THOUSANDS)
Minimum fees.............. $ 809 $ 792 $ 2,509 $ 2,420
Contingent fees........... 27,396 27,089 89,330 85,350
--------------- -------------- -------------- ---------------
Total................... $ 28,205 $ 27,881 $ 91,839 $ 87,770
=============== ============== ============== ===============
13
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - LONG-TERM INCENTIVE PLANS AND OTHER
Pursuant to the Holding Company's stock repurchase program the Holding
Company may, at the discretion of management, purchase up to $12.6 million of
its Common Stock, from time to time through September 30, 2005. The extent and
timing of repurchases will depend upon general business and market conditions,
stock prices, availability under the Revolving Credit Facility, compliance with
certain restrictive covenants and our cash position and requirements going
forward. The repurchase program may be modified, extended or terminated by the
Board of Directors at any time. Through 2003, the Holding Company repurchased a
total of 1,815,159 shares for approximately $20,537,000. For the thirty-nine
weeks ended October 30, 2004 and November 1, 2003, the Holding Company
repurchased 392,745 shares and 370,238 shares for $6,862,000 and $5,018,000,
respectively. The Holding Company's repurchases from inception of the program to
date total 2,207,904 shares for $27,399,000.
In February 2001, an executive officer of Finlay was issued 100,000 shares
of Common Stock of the Holding Company, subject to restrictions ("Restricted
Stock"), pursuant to a restricted stock agreement. The Restricted Stock becomes
fully vested after four years of continuous employment with Finlay and is
accounted for as a component of the Holding Company's stockholders' equity.
Compensation expense of approximately $1.2 million is being amortized over four
years. Amortization for each of the thirteen week periods ended October 30, 2004
and November 1, 2003 totaled approximately $78,000. Amortization for each of the
thirty-nine week periods ended October 30, 2004 and November 1, 2003 totaled
approximately $230,000.
In August 2003, an executive officer of Finlay was issued an additional
50,000 shares of Restricted Stock, pursuant to a restricted stock agreement. The
Restricted Stock vests fifty percent on January 31, 2005, with the remaining
fifty percent vesting on June 30, 2007, subject to the provisions of the
restricted stock agreement, and is accounted for as a component of the Holding
Company's stockholders' equity. Compensation expense of approximately $774,000
is being amortized over the respective vesting periods. Amortization for the
thirteen weeks ended October 30, 2004 and November 1, 2003 totaled $92,000 and
$78,000, respectively. Amortization for the thirty-nine weeks ended October 30,
2004 and November 1, 2003 totaled $275,000 and $78,000, respectively.
In October 2003, certain executives of Finlay were awarded a total of
31,250 shares of Restricted Stock, pursuant to restricted stock agreements. The
Restricted Stock becomes fully vested after four years of continuous employment
with Finlay and is accounted for as a component of the Holding Company's
stockholders' equity with respect to unamortized restricted stock compensation.
However, such shares are not considered outstanding. Compensation expense of
approximately $473,000 is being amortized over four years. Amortization for the
thirteen weeks and thirty-nine weeks ended October 30, 2004 totaled $30,000 and
$90,000, respectively.
In April 2004, certain executives of Finlay were awarded a total of 32,500
shares of Restricted Stock, pursuant to restricted stock agreements. The
Restricted Stock becomes fully vested after two years of continuous employment
with Finlay and is accounted for as a component of the Holding Company's
stockholders' equity with respect to unamortized restricted stock compensation.
However, such shares are not considered outstanding. Compensation expense of
approximately $629,000 is being amortized over two years. Amortization for the
thirteen weeks and thirty-nine weeks ended October 30, 2004 totaled $79,000 and
$156,000, respectively.
14
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - EXECUTIVE AND DIRECTOR DEFERRED COMPENSATION AND STOCK PURCHASE PLANS
In April 2003, the Board of Directors of the Holding Company adopted the
Executive Deferred Compensation and Stock Purchase Plan and the Director
Deferred Compensation and Stock Purchase Plan, which was approved by the Holding
Company's stockholders on June 19, 2003 (the "RSU Plans"). Under the RSU Plans,
key executives of Finlay and the Holding Company's non-employee directors as
designated by the Holding Company's Compensation Committee, are eligible to
acquire restricted stock units ("RSUs"). An RSU is a unit of measurement
equivalent to one share of common stock, but with none of the attendant rights
of a stockholder of a share of common stock. Two types of RSUs are awarded under
the RSU Plans: (i) participant RSUs, where a plan participant may elect to
defer, in the case of an executive employee, a portion of his or her actual or
target bonus, and in the case of a non-employee director, his or her retainer
fees and Committee chairmanship fees, and receive RSUs in lieu thereof and (ii)
matching RSUs, where the Holding Company will credit a participant's plan
account with one matching RSU for each participant RSU that a participant elects
to purchase. While participant RSUs are fully vested at all times, matching RSUs
are subject to vesting and forfeiture as set forth in the RSU Plans. At the time
of distribution under the RSU Plans, RSUs are converted into actual shares of
Common Stock of the Holding Company. As of October 30, 2004, 93,742 restricted
stock units have been awarded under the RSU Plans. Amortization for the thirteen
weeks ended October 30, 2004 and November 1, 2003 totaled approximately $98,000
and $10,000, respectively. Amortization for the thirty-nine weeks ended October
30, 2004 and November 1, 2003 totaled $232,000 and $10,000, respectively.
NOTE 9 - DEPARTMENT CLOSINGS
In July 2003, May announced its intention to divest 32 Lord & Taylor
stores, as well as two other stores in its Famous-Barr division resulting in the
closure of nine departments in 2003 and ten departments during the thirty-nine
weeks ended October 30, 2004. In 2003, we generated approximately $20.0 million
in sales from these 34 departments. Currently, May has not announced a specific
timeline for when the remaining stores will close, with the exception of one
store expected to close in the fourth quarter of 2004. For the thirty-nine weeks
ended October 30, 2004 and November 1, 2003, we recorded charges of
approximately $0.9 million and $0.3 million, respectively, relating to the
accelerated depreciation of fixed assets, the loss on disposal of fixed assets
and severance.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
From time to time, we are involved in litigation relating to claims arising
out of our operations in the normal course of business. As of December 3, 2004,
we are not a party to any legal proceedings that, individually or in the
aggregate, are reasonably expected to have a material adverse effect on our
business, results of operations, financial condition or cash flows. However, the
results of these matters cannot be predicted with certainty, and an unfavorable
resolution of one or more of these matters could have a material adverse effect
on our consolidated financial statements.
We have not provided any third-party financial guarantees as of and for the
thirty-nine weeks ended October 30, 2004.
15
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - DISCONTINUED OPERATIONS
In August 2003, the Holding Company announced that Federated would not
renew our lease in the Burdines department store division due to the planned
consolidation of the Burdines and Macy's fine jewelry departments in early 2004.
The termination of the lease, effective January 31, 2004, resulted in the
closure of 46 Finlay departments in the Burdines department store division. In
2003, we generated approximately $55.0 million in sales from the Burdines
departments. The results of operations of the Burdines departments have been
segregated from those of continuing operations, net of tax, and classified as
discontinued operations for the thirteen weeks and thirty-nine weeks ended
November 1, 2003.
A summary of statements of operations information relating to the
discontinued operations is as follows (in thousands):
THIRTEEN WEEKS THIRTY-NINE WEEKS
ENDED ENDED
NOVEMBER 1, 2003 NOVEMBER 1, 2003
------------------ ------------------
Sales....................................................... $ 9,149 $ 30,473
Income (loss) before income taxes (1) (2)................... (204) 1,534
Discontinued operations, net of tax......................... (123) 938
- ----------------------
(1) Includes an allocation of $46,000 and $142,000 for the thirteen weeks
and the thirty-nine weeks ended November 1, 2003, respectively, of
interest expense related to the Revolving Credit Agreement.
(2) The results of operations of the Burdines departments excludes allocations
of general and administrative expenses and interest expense related to the
Senior Notes and the Senior Debentures.
16
PART I - FINANCIAL INFORMATION
- -------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
Our Management's Discussion and Analysis of Financial Condition and Results
of Operations ("MD&A") is provided as a supplement to the accompanying
consolidated financial statements and notes thereto contained in Item 1 of this
report. This MD&A is organized as follows:
o EXECUTIVE OVERVIEW - This section provides a general description of our
business and a brief discussion of the opportunities, challenges and
risks that we focus on in the operation of our business.
o RESULTS OF OPERATIONS - This section provides an analysis of the
significant line items on the consolidated statements of operations.
o LIQUIDITY AND CAPITAL RESOURCES - This section provides an analysis of
liquidity, cash flows, sources and uses of cash, contractual
obligations and financial position.
o SEASONALITY - This section describes the effects of seasonality on our
business.
o CRITICAL ACCOUNTING POLICIES AND ESTIMATES - This section discusses
those accounting policies that both are considered important to our
financial condition and results of operations, and require us to
exercise subjective or complex judgments in their application. In
addition, all of our significant accounting policies, including
critical accounting policies, are summarized in Note 2 to the
consolidated financial statements included in our Form 10-K.
o SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS - This section
provides cautionary information about forward-looking statements and a
description of certain risks and uncertainties that could cause actual
results to differ materially from our historical results or current
expectations or projections.
The results of operations for the thirteen weeks and thirty-nine weeks
ended November 1, 2003 reflect the Burdines departments as a discontinued
operation.
EXECUTIVE OVERVIEW
- ------------------
OUR BUSINESS
We are one of the leading retailers of fine jewelry in the United States
and operate fine jewelry departments in major department stores for retailers
such as May and Federated. We sell a broad selection of moderately priced
jewelry, with an average sales price of approximately $191 per item. As of
October 30, 2004, we operated 975 locations in 16 host store groups, in 46
states and the District of Columbia.
Our primary focus is to offer high quality, desirable and competitively
priced products, a breadth of merchandise assortments and to provide superior
customer service. Our ability to quickly identify emerging trends and maintain
strong relationships with vendors has enabled us to present better assortments
in our showcases. We believe that we are an important contributor to each of our
host store groups and we continue to seek opportunities to penetrate the
department store segment. By outsourcing their fine jewelry departments to us,
host store groups gain our expertise in merchandising, selling and marketing
jewelry and customer service. Additionally, by avoiding high working capital
investments
17
typically required of the traditional retail jewelry business, host stores
improve their return on investment and increase their profitability. As a
lessee, we benefit from the host stores' reputation, customer traffic, credit
services and established customer base. We also avoid the substantial capital
investment in fixed assets typical of a stand-alone retail format. These factors
have generally led our new departments to achieve profitability within the first
twelve months of operation.
We measure ourselves against key financial measures that we believe provide
a well-balanced perspective regarding our overall financial success. Those
benchmarks are as follows, together with how they are computed:
o Comparable department sales growth computed as the percentage change in
sales for departments open for the same months during the comparable
periods. Comparable department sales are measured against our host
store groups as well as other jewelry retailers;
o Total sales growth (current period total sales minus prior period total
sales divided by prior period total sales equals percentage change)
which indicates, among other things, the success of our selection of
new store locations and the effectiveness of our merchandising
strategies; and
o Operating margin rate (income from operations divided by net sales)
which is an indicator of our success in leveraging our fixed costs and
managing our variable costs.
THIRD QUARTER HIGHLIGHTS
During the third quarter of 2004, we continued to successfully execute our
marketing and merchandising strategy. Total sales were $166.8 million for the
thirteen weeks ended October 30, 2004 compared to $165.8 million for the
thirteen weeks ended November 1, 2003, an increase of 0.6%. Comparable
department sales increased 0.7%. Gross margin decreased by $0.1 million compared
to 2003, and as a percentage of sales, gross margin decreased by 0.4% from 51.1%
to 50.7%. SG&A increased $2.2 million and as a percentage of sales, SG&A
increased 1.0% from 48.5% to 49.5%. Borrowings under the Revolving Credit
Agreement increased by $24.0 million at October 30, 2004 as compared to November
1, 2003, primarily as a result of the refinancing of the Senior Notes and the
Senior Debentures. Maximum outstanding borrowings during the thirty-nine weeks
ended October 30, 2004 peaked at $99.8 million, at which point the available
borrowings under the Revolving Credit Agreement were an additional $113.5
million.
OUTLOOK
We continue to seek growth opportunities and plan to continue to pursue the
following key initiatives:
o Increase comparable department sales;
o Add departments within existing host store groups;
o Add new host store relationships;
o Open new channels of distribution;
o Continue to raise customer service standards;
o Strengthen selling teams through training programs;
18
o Continue to improve operating leverage; and
o De-leverage the balance sheet.
We believe that current trends in jewelry retailing provide a significant
opportunity for our growth. Consumers spent approximately $54.0 billion on
jewelry (including both fine jewelry and costume jewelry) in the United States
in calendar year 2003, an increase of approximately $19.9 billion over 1993,
according to the United States Department of Commerce, representing a compound
annual growth rate of 4.7%. In the department store sector in which we operate,
consumers spent an estimated $4.0 billion on fine jewelry in calendar year 2002.
Our management believes that demographic factors such as the maturing U.S.
population and an increase in the number of working women, have resulted in
greater disposable income, thus contributing to the growth of the fine jewelry
retailing industry. Our management also believes that jewelry consumers today
increasingly perceive fine jewelry as a fashion accessory, resulting in
purchases which augment our gift and special occasion sales.
OPPORTUNITIES, RISKS AND UNCERTAINTIES
We achieved sustained growth during 2003 and the nine months of 2004,
however, we faced certain challenges as well, including:
o Dependence on or loss of certain host store relationships; and
o Host store consolidation.
During 2003, Federated announced that it would not renew our lease in the
Burdines department store division, which resulted in the closure of 46 Burdines
departments in January 2004. These 46 departments generated approximately $55
million in revenue during 2003, which is included in discontinued operations.
Due to the termination of the Burdines lease, we recorded a non-cash charge of
$13.8 million in 2003 for the write-down of goodwill resulting from the closure
of the Burdines departments.
Additionally, during 2003, May announced its intention to close certain of
its smaller, less profitable stores, including 32 Lord & Taylor stores, as well
as two stores in its Famous-Barr division, resulting in the closure of nine
departments in 2003 and ten departments during the thirty-nine weeks ended
October 30, 2004. In 2003, we generated approximately $20 million in sales from
these 34 departments.
During 2003, approximately 51% and 18% of our sales were generated by
departments operated in store groups owned by May and Federated, respectively.
Including our sales in Marshall Fields which May recently acquired, departments
operated by May would have accounted for 60% of our sales in 2003. We have
operated departments with May since 1948 and with Federated since 1983. We
believe that our relationships with these host stores are excellent.
Nevertheless, a decision by either company to transfer the operation of some or
all of their departments to a competitor or to assume the operation of those
departments themselves would have a material adverse effect on our business and
financial condition. Additionally, the department store industry may experience
significant consolidations in the future, however, there is no assurance that
our host store relationships will not be impacted as a result of such host store
consolidation.
An important initiative and focus of management is developing
opportunities for our growth. We consider it a high priority to identify new
businesses that offer growth, financial viability and manageability and will
have a positive impact on shareholder value.
19
RESULTS OF OPERATIONS
- ---------------------
The following table sets forth operating results as a percentage of sales
for the periods indicated. The discussion that follows should be read in
conjunction with the following table:
STATEMENTS OF OPERATIONS DATA
THIRTEEN WEEKS ENDED THIRTY-NINE WEEKS ENDED
---------------------------- -----------------------------
OCTOBER 30, NOVEMBER 1, OCTOBER 30, NOVEMBER 1,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Sales...................................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales.............................................. 49.3 48.9 49.1 48.7
----------- ----------- ----------- -----------
Gross margin........................................... 50.7 51.1 50.9 51.3
Selling, general and administrative expenses............... 49.5 48.5 47.5 47.5
Depreciation and amortization.............................. 2.6 2.6 2.4 2.4
----------- ----------- ----------- -----------
Income (loss) from operations.......................... (1.4) - 1.0 1.4
Interest expense, net...................................... 3.3 2.6 2.7 2.4
Other expense - debt extinguishment costs.................. - - 1.1 -
----------- ----------- ----------- -----------
Loss from continuing operations before
income taxes......................................... (4.7) (2.6) (2.8) (1.0)
Benefit for income taxes................................... (1.8) (1.0) (1.2) (0.4)
----------- ----------- ----------- -----------
Loss from continuing operations........................ (2.9) (1.6) (1.6) (0.6)
Discontinued operations, net of tax........................ - - - 0.2
----------- ----------- ----------- -----------
Net loss............................................... (2.9) % (1.6)% (1.6)% (0.4)%
=========== =========== =========== ===========
THIRTEEN WEEKS ENDED OCTOBER 30, 2004 COMPARED WITH THIRTEEN WEEKS ENDED
NOVEMBER 1, 2003
SALES. Sales for the thirteen weeks ended October 30, 2004 increased $1.1
million, or 0.6%, over the comparable period in 2003. Comparable department
sales (departments open for the same months during the comparable periods)
increased 0.7%. 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 "destination locations" for fine jewelry.
During the thirteen weeks ended October 30, 2004, we opened twelve
departments, including three departments in Dillard's and closed four
departments. The openings and closings were all within existing store groups.
GROSS MARGIN. Gross margin for the period decreased by $0.1 million in 2004
compared to 2003, and, as a percentage of sales, gross margin decreased by 0.4%.
The components of this 0.4% net decrease in gross margin are as follows:
20
COMPONENT % REASON
----------------------------------- ---------------- --------------------------------------------------
Merchandise cost of sales......... (0.9) Increase in merchandise cost of sales is primarily due
to our continued efforts to increase market penetration
and market share through our pricing strategy, as well
as the mix of sales with increased sales in the diamond,
designer and clearance categories, which have lower
margins than other categories.
LIFO ............................. 0.3 Net decrease in the LIFO provision from $0.8 million in
the 2003 period to $0.3 million in the 2004 period. As
discussed in Note 5 to the accompanying consolidated
financial statements, we changed our method of valuing
inventory for LIFO purposes. Under the former method,
the LIFO charge would have increased to $1.3 million,
which is $1.0 million more than the LIFO charge under
the new method.
Shortage ......................... 0.2 The 2004 physical inventory results (actual shortage vs.
accrual) were more favorable as compared to the 2003
results.
------
Total ............... (0.4)%
======
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 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 change in accounting method is an alternative
accounting principle that is preferable under the circumstances described above.
As a result of this change in accounting method, we recorded LIFO charges of
approximately $0.3 million and $0.9 million for the thirteen weeks and
thirty-nine weeks ended October 30, 2004, respectively. Using the BLS producer
price indices, the LIFO charge for the thirteen weeks and thirty-nine weeks
ended October 30, 2004 would have been $1.3 million and $4.4 million,
respectively. Had we not changed our method of determining price indices, the
net loss under the former LIFO method for the thirteen weeks and thirty-nine
weeks ended October 30, 2004 would have been approximately $5.5 million and
approximately $10.8 million, respectively.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The components of SG&A
include payroll expense, lease fees, net advertising expenditures and other
field and administrative expenses. SG&A increased $2.2 million, or 2.7%. As a
percentage of sales, SG&A increased by 1.0%. The components of this 1.0% net
increase in SG&A are as follows:
COMPONENT % REASON
----------------------------------- ---------------- --------------------------------------------------
Net advertising expenditures...... 0.3 Decrease in net advertising expenditures is due to lower
gross advertising as a percentage of sales.
Lease fees........................ (0.1) Increase in lease fees is due to a change in the mix of
host store group sales.
Payroll expense .................. (0.8) Although sales increased over the prior year, the
increase in payroll expense is due to lower than
expected same store sales negatively impacting the
leveraging of payroll expense.
Other expenses ................... (0.4) Increase in other expenses is due primarily to lower
than expected same store sales negatively impacting the
leveraging of these expenses.
-----
Total ............... (1.0)%
=====
21
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased by
$0.1 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 $0.1 million, associated with the Lord & Taylor
store closings, were recorded in the period.
INTEREST EXPENSE, NET. Interest expense increased by $1.4 million primarily
due to an increase in average borrowings ($280.2 million for the period in 2004
compared to $203.5 million for the comparable period in 2003) as a result of the
sale of the New Senior Notes, which was undertaken as part of the refinancing of
the Senior Notes. The weighted average interest rate was approximately 7.1% for
the 2004 period compared to 6.9% for the comparable period in 2003.
BENEFIT FOR INCOME TAXES. The income tax benefit for both the 2004 and 2003
periods reflects effective tax rates of 39%.
DISCONTINUED OPERATIONS. Discontinued operations includes the results of
operations of the Burdines departments. The loss from discontinued operations,
net of tax, for the 2003 period was $0.1 million.
NET LOSS. Net loss of $4.8 million for the 2004 period, represents an
increase of $2.1 million as compared to the net loss of $2.7 million in the
prior period as a result of the factors discussed above.
THIRTY-NINE WEEKS ENDED OCTOBER 30, 2004 COMPARED WITH THIRTY-NINE WEEKS ENDED
NOVEMBER 1, 2003
SALES. Sales for the thirty-nine weeks ended October 30, 2004 increased
$19.6 million, or 3.7%, over the comparable period in 2003. Comparable
department sales increased 3.6%.
During the thirty-nine weeks ended October 30, 2004, we opened 25
departments and closed 22 departments. The openings and closings were all within
existing store groups. The openings included eleven departments in Dillard's and
the closings included nine departments in Lord & Taylor and one in Famous Barr
as a result of May's decision to close certain of its smaller, less profitable
stores.
GROSS MARGIN. Gross margin for the period increased by $8.2 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:
22
COMPONENT % REASON
----------------------------------- ---------------- --------------------------------------------------
Merchandise cost of sales......... (0.7) Increase in merchandise cost of sales is primarily due
to our continued efforts to increase market penetration
and market share through our pricing strategy, as well
as the mix of sales with increased sales in the diamond,
designer, and clearance categories, which have lower
gross margins than other categories.
LIFO ............................. 0.2 Net decrease in the LIFO provision from $2.2 million in
the 2003 period to $0.9 million in the 2004 period. As
discussed in Note 5 of the accompanying consolidated
financial statements, we changed our method of valuing
inventory for LIFO purposes. Under the former method,
the LIFO charge would have increased to $4.4 million,
which is $3.5 million more than the LIFO charge under
the new method.
Shortage ......................... 0.1 The 2004 physical inventory results (actual shortage vs.
accrual) were more favorable compared to the 2003
results.
-----
Total ............... (0.4)%
=====
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The components of SG&A
include payroll expense, lease fees, net advertising expenditures and other
field and administrative expenses. SG&A increased $9.6 million, or 3.9%. As a
percentage of sales, SG&A remained flat at 47.5%.
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 $0.4 million, associated with the Lord & Taylor
store closings, were recorded in the period.
INTEREST EXPENSE, NET. Interest expense increased by $2.2 million primarily
due to an increase in average borrowings ($227.2 million for the period in 2004
compared to $192.3 million for the comparable period in 2003) as a result of the
sale of the New Senior Notes, which was undertaken as part of the refinancing of
the Senior Notes. The weighted average interest rate was approximately 7.4% for
the 2004 period compared to 7.3% for the comparable period in 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.
BENEFIT FOR INCOME TAXES. The income tax benefit for both the 2004 and 2003
periods reflects effective tax rates of 39%. Additionally, the 2004 period
includes a benefit of approximately $0.6 million associated with the reversal of
tax accruals no longer required.
DISCONTINUED OPERATIONS. Discontinued operations includes the results of
operations of the Burdines departments. Income from discontinued operations, net
of tax, for the 2003 period was $0.9 million.
NET LOSS. Net loss of $8.7 million for the 2004 period represents an
increase of $6.4 million as compared to the net loss of $2.3 million in the
prior period as a result of the factors discussed above.
23
LIQUIDITY AND CAPITAL RESOURCES
Information about our financial position as of October 30, 2004 and
January 31, 2004 is presented in the following table:
OCTOBER 30, JANUARY 31,
2004 2004
------------- -----------------
(DOLLARS IN THOUSANDS)
Cash and cash equivalents......... $ 1,713 $ 89,481
Working capital................... 199,782 196,496
Long-term debt.................... 200,000 150,000
Stockholder's equity.............. 137,453 185,100
Our primary capital requirements are for funding working capital for new
departments and for growth of existing departments, as well as debt service
obligations and lease payments to host store groups, and, to a lesser extent,
capital expenditures for opening new departments, renovating existing
departments and information technology investments. For 2003, capital
expenditures totaled $12.9 million and for 2004 are estimated to be
approximately $12 to $13 million. Although capital expenditures are limited by
the terms of the Revolving Credit Agreement, to date, this limitation has not
precluded us from satisfying our capital expenditure requirements.
We currently expect to fund capital expenditure requirements as well as
liquidity needs from a combination of cash, internally generated funds and
borrowings under our Revolving Credit Agreement. We believe that our internally
generated liquidity through cash flows from operations, together with access to
external capital resources, will be sufficient to satisfy existing commitments
and plans and will provide adequate financing flexibility.
Cash flows provided from (used in) operating, investing and financing
activities for the thirty-nine weeks ended October 30, 2004 and November 1, 2003
were as follows:
THIRTY-NINE WEEKS ENDED
---------------------------------
OCTOBER 30, NOVEMBER 1,
2004 2003
--------------- --------------
(DOLLARS IN THOUSANDS)
Operating activities........................ $ (168,833) $ (119,405)
Investing activities........................ (8,914) (8,001)
Financing activities........................ 89,979 60,057
Net decrease in cash and cash --------------- ---------------
equivalents ...................... $ (87,768) $ (67,349)
=============== ===============
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.
24
OPERATING ACTIVITIES
The primary source of our liquidity is cash flows from operating
activities. The key component of operating cash flow is merchandise sales.
Operating cash outflows include payments to vendors for inventory, services and
supplies, payments for employee payroll, lease payments and payments of interest
and taxes. Net cash flows used in operating activities were $168.8 million for
the thirty-nine weeks ended October 30, 2004, consisting principally of a
decrease in accounts payable primarily due to lower inventory receipts and lower
consignment inventory sales as well as a decrease in net current deferred tax
assets related to a change in accounting method for tax purposes regarding
vendor allowances. Net cash flows used in operating activities was $119.4
million for the thirty-nine weeks ended November 1, 2003.
Our operations substantially preclude customer receivables as our lease
agreements require host stores to remit sales proceeds for each month (without
regard to whether such sales were cash, store credit or national credit card) to
us approximately three weeks after the end of such month. However, we cannot
ensure the collection of sales proceeds from our host stores. Additionally, on
average, approximately 50% of our merchandise has been carried on consignment.
Our working capital balance was $199.8 million at October 30, 2004, an increase
of $3.3 million from January 31, 2004, resulting primarily from the impact of
the interim net loss (exclusive of depreciation and amortization), capital
expenditures, the payment of dividends to the Holding Company and additional
borrowings under the Revolving Credit Agreement related to 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 lease agreements
provide for accelerated payments during the months of November and December,
which require the host store groups to remit to us 75% of the estimated months'
sales prior to or shortly following the end of that month. These proceeds result
in a significant increase in our cash, which is used to reduce our borrowings
under the Revolving Credit Agreement. Inventory levels increased by $5.1
million, or 1.7 %, as compared to November 1, 2003 somewhat as a result of
further investments in the diamond and designer categories.
INVESTING ACTIVITIES
Investing cash outflows include payments for capital expenditures,
including property and equipment. Net cash used in investing activities was $8.9
million and $8.0 million for the thirty-nine weeks ended October 30, 2004 and
November 1, 2003, respectively. Capital expenditures during each period related
primarily to expenditures for new department openings and renovations.
FINANCING ACTIVITIES
Proceeds from, and principal payments on, the Revolving Credit Facility
offset by the payment of dividends to the Holding Company have been our primary
financing activities. Additionally, during the second quarter of 2004, we
refinanced our long-term debt. Net cash provided from financing activities was
$90.0 million for the thirty-nine weeks ended October 30, 2004, consisting
principally of proceeds from, and principal payments on, the Revolving Credit
Facility and proceeds from the issuance of the New Senior Notes, offset by the
purchase and redemption of the outstanding Senior Notes and payment of dividends
to the Holding Company. Net cash provided from financing activities was $60.1
million for the thirty-nine weeks ended November 1, 2003.
In January 2003, we entered into the Revolving Credit Agreement, which
expires in January 2008. The Revolving Credit Agreement provides us with a line
of credit of up to $225.0 million to finance
25
working capital needs. Amounts outstanding under the Revolving Credit Agreement
bear interest at a rate equal to, at our option, (i) the prime rate plus a
margin ranging from zero to 1.0% or (ii) the adjusted Eurodollar rate plus a
margin ranging from 1.0% to 2.0%, in each case depending on our financial
performance. The weighted average interest rate was 3.7% and 3.3% for the
thirty-nine weeks ended October 30, 2004 and November 1, 2003, respectively.
In each year, we are required to reduce the outstanding revolving credit
balance and letter of credit balance under the Revolving Credit Agreement to
$50.0 million or less and $20.0 million or less, respectively, for a 30
consecutive day period (the "Balance Reduction Requirement"). Borrowings under
the Revolving Credit Agreement were $78.5 million at October 30, 2004, compared
to a zero balance at January 31, 2004 and $54.5 million at November 1, 2003. The
average amounts outstanding under the Revolving Credit Agreement were $49.4
million and $42.3 million for the thirty-nine weeks ended October 30, 2004 and
November 1, 2003, respectively. The maximum amount outstanding for the
thirty-nine weeks ended October 30, 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, commencing 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 it 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 simplify
our capital structure by eliminating debt at the parent company level, as well
as decreasing total long-term debt, decreasing our overall interest rate and
extending our debt maturities. As a result of the completion of the redemption
of the Senior Debentures, we are no longer required to provide the funds
necessary to pay the higher debt service costs associated with the Senior
Debentures.
We incurred approximately $5.1 million in costs, including $4.9 million
associated with the sale of the New Senior Notes, which have been deferred and
are being amortized over the term of the New Senior Notes. In June 2004, we
recorded pre-tax charges of approximately $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 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.
26
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
Notes and the Senior Debentures 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 October 30, 2004, our outstanding
borrowings were $278.5 million, which included a $200.0 million balance under
the New Senior Notes and a $78.5 million balance under the Revolving Credit
Agreement.
Our agreements covering the Revolving Credit Agreement and the New Senior
Notes each require that we comply with certain restrictive and financial
covenants. In addition, we are a party to the Gold Consignment Agreement, which
also contains certain covenants. As of and for the thirty-nine weeks ended
October 30, 2004, we are in compliance with all of our covenants. We expect to
be in compliance with all of our covenants through 2004. Because compliance is
based, in part, on our management's estimates and actual results can differ from
those estimates, there can be no assurance that we will be in compliance with
the covenants in the future or that the lenders will waive or amend any of the
covenants should we be in violation thereof. We believe the assumptions used are
appropriate.
The Revolving Credit Agreement contains customary covenants, including
limitations on, or relating to, capital expenditures, liens, indebtedness,
investments, mergers, acquisitions, affiliate transactions, management
compensation and the payment of dividends and other restricted payments. The
Revolving Credit Agreement also contains various financial covenants, including
minimum earnings and fixed charge coverage ratio requirements and certain
maximum debt limitations.
The indenture related to the New Senior Notes contains restrictions
relating to, among other things, the payment of dividends, redemptions or
repurchases of capital stock, the incurrence of additional 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. Other dividends and distributions,
including those required to fund stock repurchases, are subject to our
satisfaction of certain restrictive covenants. The amounts required to satisfy
the aggregate of our interest expense totaled $10.0 million and $8.8 million for
the thirty-nine weeks ended October 30, 2004 and November 1, 2003, respectively.
Our long-term needs for external financing will depend on our rate of
growth, the level of internally generated funds and the ability to continue
obtaining substantial amounts of merchandise on advantageous terms, including
consignment arrangements with our vendors. As of October 30, 2004, $387.8
million of consignment merchandise from approximately 300 vendors was on hand as
compared to $381.8 million at November 1, 2003. For 2003, we had an average
balance of consignment merchandise of $364.7 million.
27
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 October 30, 2004 (dollars in thousands):
PAYMENTS DUE BY PERIOD
------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL LESS THAN 1 YEAR 1 - 3 YEARS 3 - 5 YEARS MORE THAN 5 YEARS
- ------------------------------ --------------- ----------------- ------------ ------------- -------------------
Long-Term Debt Obligations:
New Senior Notes (due 2012) (1) .. $ 200,000 $ - $ - $ - $ 200,000
Interest payments on New Senior
Notes ............................ 134,000 16,750 33,500 33,500 50,250
Operating lease obligations (2)..... 9,070 2,028 3,847 3,195 -
Revolving Credit
Agreement (due 2008) (3).......... 78,497 78,497 - - -
Gold Consignment
Agreement (expires 2005).......... 49,200 49,200 - - -
Gold forward contracts.............. 12,362 12,362 - - -
Letters of credit................... 11,690 11,440 - 250 -
---------- ---------- --------- ---------- ----------
Total............................... $ 494,819 $ 170,277 $ 37,347 $ 36,945 $ 250,250
========== ========== ========= ========== ==========
(1) On June 3, 2004, we issued $200.0 million of New Senior Notes due 2012.
Refer to Note 4 of Notes to the Consolidated Financial Statements.
(2) Represents future minimum payments under noncancellable operating leases as
of January 31, 2004.
(3) The outstanding balance under the Revolving Credit Agreement at December 3,
2004 was $93.4 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 October 30, 2004, other than as disclosed in the table above,
nor have we provided any third-party financial guarantees as of and for the
thirty-nine weeks ended October 30, 2004.
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 believe
our relationship with the gold consignor is good and we expect to be in a
position to extend the Gold Consignment Agreement upon its expiration. At
October 30, 2004, amounts outstanding under the Gold Consignment Agreement
totaled 115,615 fine troy ounces, valued at $49.2 million. The average amount
outstanding under the Gold Consignment Agreement was $48.0 million in 2003. 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
October 30, 2004, we were in compliance with all of our covenants under the Gold
Consignment Agreement.
28
We have not created, and are not party to, any off-balance sheet entities
for the purpose of raising capital, incurring debt or operating our business. We
do not have any arrangements or relationships with entities that are not
consolidated into the financial statements that are reasonably likely to
materially affect our liquidity or the availability of capital resources.
OTHER ACTIVITIES AFFECTING LIQUIDITY
We have an employment agreement with one senior executive which provides
for a base salary level as well as incentive compensation based on meeting
specific financial goals. This agreement expires on January 31, 2005 and has a
remaining aggregate value of $0.3 million as of October 30, 2004. In December
2004, we entered into a new employment agreement with the aforementioned 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 by
the senior executive, in accordance with the provisions of the employment
agreement. The new employment agreement provides a base 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 October 30, 2004, we had several open
positions in gold forward contracts totaling 31,500 fine troy ounces, to
purchase gold for $12.4 million. There can be no assurance that these hedging
techniques will be successful or that hedging transactions will not adversely
affect our results of operations or financial position.
In January 2000, Sonab, our European leased jewelry department subsidiary,
sold the majority of its assets for approximately $9.9 million. We recorded a
pre-tax charge in the fourth quarter of 1999 of $28.6 million. As of October 30,
2004, our exit plan has been completed with the exception of certain employee
litigation and other legal matters. To date, we have charged a total of $26.4
million against our revised estimate of $27.2 million. We do not believe future
operating results or liquidity will be materially impacted by any remaining
payments or litigation and legal matters mentioned above.
SEASONALITY
Our business is highly seasonal, with a significant portion of our sales
and income from operations generated during the fourth quarter of each year,
which includes the year-end holiday season. The fourth quarter of 2003 accounted
for approximately 42% of our sales and approximately 86% of our income from
operations. We have typically experienced net losses in the first three quarters
of our fiscal year. During these periods, working capital requirements have been
funded by borrowings under the Revolving Credit Agreement. Accordingly, the
results for any of the first three quarters of any given fiscal year, taken
individually or in the aggregate, are not indicative of annual results.
INFLATION
The effect of inflation on our results of operations has not been material
in the periods discussed.
29
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- ------------------------------------------
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 included in our Form 10-K for the year
ended January 31, 2004.
MERCHANDISE INVENTORIES
We value our inventories at the lower of cost or market. The cost is
determined by the last-in, first-out method. We are required to determine the
LIFO cost on an interim basis by estimating annual inflation trends, annual
purchases and ending inventory levels for the fiscal year. Actual annual
inflation rates and inventory balances as of the end of any fiscal year may
differ from interim estimates. 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 the finite-lived assets
are less than the carrying value, we recognize a loss equal to the difference
between the carrying value and the fair value of the assets. We determine the
fair value of the underlying assets based upon the discounted future cash flows
of the assets. Various factors, including future sales growth and profit
margins, are included in this analysis. To the extent these future projections
or our strategies change, the conclusion regarding impairment may differ from
the current estimates.
30
GOODWILL
We evaluate goodwill for impairment annually or whenever events and changes
in circumstances suggest that the carrying amount may not be recoverable from
our estimated future cash flows. To the extent these future cash flows or our
strategies change, the conclusion regarding impairment may differ from current
estimates.
REVENUE RECOGNITION
We recognize revenue upon the sale of merchandise, either owned or
consigned, to our customers, net of anticipated returns. The provision for sales
returns is based on our historical return rate.
SELF-INSURANCE RESERVES
We are self-insured for medical and workers' compensation claims up to
certain maximum liability amounts. Although the amounts accrued are actuarially
determined based on analysis of historical trends of losses, settlements,
litigation costs and other factors, the amounts that we will ultimately disburse
could differ materially from the accrued amounts.
INCOME TAXES
We are subject to income taxes in many jurisdictions and must first
determine which revenues and expenses should be included in each taxing
jurisdiction. This process involves the estimation of our actual current tax
exposure, together with the assessment of temporary differences resulting from
differing treatment of income or expense items for tax and accounting purposes.
We establish tax reserves in our consolidated financial statements based on our
estimation of current tax exposures. If we prevail in tax matters for which
reserves have been established or if we are required to settle matters in excess
of established reserves, the effective tax rate for a particular period could be
materially affected.
RECENT ACCOUNTING PRONOUNCEMENT
In June 2004, the FASB issued an interpretation of FASB No. 143,
"Accounting for Asset Retirement Obligations". This interpretation clarifies the
scope and timing of liability recognition for conditional asset retirement
obligations under FASB No. 143, and is effective no later than the end of our
2005 fiscal year. We have determined that this interpretation, and the adoption
of FASB No. 143, will not have a material impact on our consolidated financial
statements.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
- -------------------------------------------------
This Form 10-Q includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 (the "Securities Act") and Section 21E
of the Securities Exchange Act of 1934. All statements other than statements of
historical information provided herein are forward-looking statements and may
contain information about financial results, economic conditions, trends and
known uncertainties. The forward-looking statements contained herein are subject
to certain risks and uncertainties that could cause actual results, performances
or achievements to differ materially from those reflected in, or implied by, the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed under "Management's Discussion and
Analysis of Financial Condition and Results of Operations". Important factors
that could cause actual results to differ materially include, but are not
limited to:
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o our dependence on or loss of certain host store relationships,
particularly with respect to May and Federated, due to the
concentration of sales generated by such host stores;
o the impact of significant store closures by our host store groups;
o the seasonality of the retail jewelry business;
o the impact of changes in the popularity of malls and our host stores
and mall traffic levels;
o our ability to continue to obtain substantial amounts of merchandise
on consignment;
o the continuation of our Gold Consignment Agreement;
o the impact of fluctuations in gold and diamond prices;
o attacks or threats of attacks by terrorists or war which may negatively
impact the economy and/or the financial markets and reduce
discretionary spending;
o trends in the general economy in the United States;
o low or negative growth in the economy or in the financial markets
which reduce discretionary spending on goods perceived to be luxury
items;
o competition in the retail jewelry business and fluctuations in our
quarterly results;
o our ability to collect net sales proceeds from our host stores;
o the impact of any host store bankruptcy;
o the availability to us of alternate sources of merchandise supply
in the case of an abrupt loss of any significant supplier;
o our ability to identify and rapidly respond to fashion trends;
o our ability to increase comparable department sales, expand our
business or increase the number of departments we operate;
o our ability to identify, finance and integrate any future acquisitions
into our existing business;
o our dependence on key officers;
o our compliance with applicable contractual covenants;
o the impact of future claims and legal actions arising in the ordinary
course of business;
o the impact of recent accounting developments, including the impact of
proposed accounting standards to require companies to expense stock
options;
32
o our high degree of leverage and the availability to us of financing
and credit on favorable terms; and
o changes in regulatory requirements which are applicable to our
business.
Readers are cautioned not to unduly rely on these forward-looking
statements, which reflect our management's analysis, judgment, belief or
expectation only as of the date hereof. We undertake no obligation to publicly
revise these forward-looking statements to reflect events or circumstances that
arise after the date hereof or to reflect the occurrence of unanticipated
events. In addition to the disclosure contained herein, readers should carefully
review any disclosure of risks and uncertainties contained in other documents we
file or have filed from time to time with the Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
We are exposed to market risk through the interest rate on our borrowings
under the Revolving Credit Agreement, which has a variable interest rate. Based
on the average amounts outstanding under the Revolving Credit Agreement for
2003, a 100 basis point change in interest rates would have resulted in an
increase in interest expense of approximately $427,000. In seeking to minimize
the risks from interest rate fluctuations, we manage exposures through our
regular operating and financing activities. In addition, the majority of our
borrowings are under fixed rate arrangements, as described in Note 4 of Notes to
Consolidated Financial Statements.
COMMODITY RISK
We enter into forward contracts for the purchase of the majority of our
gold in order to hedge the risk of gold price fluctuations. As of October 30,
2004, we had several open positions in gold forward contracts totaling 31,500
fine troy ounces, to purchase gold for $12.4 million. The fair value of gold
under such contracts was $13.5 million at October 30, 2004. These contracts have
settlement dates ranging from December 30, 2004 through March 31, 2005.
ITEM 4. CONTROLS AND PROCEDURES
-----------------------
DISCLOSURE CONTROLS AND PROCEDURES
We carried out an evaluation under the supervision and with the
participation of our management, including our Chief Executive Officer ("CEO")
and Chief Financial Officer ("CFO"), of the effectiveness of our disclosure
controls and procedures pursuant to Securities Exchange Act Rule 13a-15 as of
the end of the period covered by this report. Based upon that evaluation, the
CEO and CFO concluded that the design and operation of these disclosure controls
and procedures are effective in reaching a reasonable level of assurance that
material financial and non-financial information required to be disclosed by us
in reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Commission's
rules and forms.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have been no changes in our internal control over financial reporting
that occurred during our last fiscal quarter to which this report relates that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
ISSUER PURCHASES OF EQUITY SECURITIES
There were no repurchases of equity securities made by the Holding Company
during the third quarter of 2004.
Pursuant to the Holding Company's stock repurchase program the Holding
Company may, at the discretion of management, purchase up to $12.6 million of
its Common Stock, from time to time through September 30, 2005. The extent and
timing of repurchases will depend upon general business and market conditions,
stock prices, availability under the Revolving Credit Facility, compliance with
certain restrictive covenants and the Holding Company's cash position and
requirements going forward. Through 2003, the Holding Company repurchased a
total of 1,815,159 shares for approximately $20,537,000. For the thirty-nine
weeks ended October 30, 2004 and November 1, 2003, the Holding Company
repurchased 392,745 shares and 370,238 shares for $6,862,000 and $5,018,000,
respectively. The Holding Company's repurchases from inception of the program to
date totaled 2,207,904 shares for $27,399,000.
ITEM 6. EXHIBITS
--------
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2 Not Applicable
3 Not Applicable
4 Not Applicable
10.1 Finlay Enterprises, Inc. 2004 Cash Bonus Plan (incorporated by
reference to Exhibit 10.1 filed as part of the Current Report
on Form 8-K filed by Registrant on September 10, 2004).
10.2 Amendment to the Finlay Enterprises, Inc. 1997 Long Term
Incentive Plan (incorporated by reference to Exhibit 10.2
filed as part of the Current Report on Form 8-K filed by
Registrant on September 10, 2004).
10.3 Consent and Amendment No. 3, dated as of November 19, 2004 to
the Second Amended and Restated Credit Agreement, dated of
January 22, 2003, among the Holding Company, Finlay Jewelry,
General Electric Capital Corporation, individually and in its
capacity as administrative agent, Fleet Precious Metals, Inc.,
individually and as documentation agent, and certain other
banks and institutions (incorporated by reference to Exhibit
10.1 filed as part of the Current Report on Form 8-K filed by
Registrant on November 24, 2004).
10.4 Seventh Amendment, dated as of November 22, 2004, among
Sovereign Bank, as agent and a bank, Sovereign Precious Metals
LLC, Commerzbank International S.A., Finlay Jewelry and
eFinlay, Inc. to the Amended and Restated Gold Consignment
Agreement, dated as of March 30, 2001, as amended
(incorporated by reference to Exhibit 10.2 filed as part of
the Current Report on Form 8-K filed by Registrant on November
24, 2004).
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10.5 Employment Agreement, dated as of January 30, 2005, among the
Holding Company, Finlay Jewelry and Arthur E. Reiner
(including the forms of restricted stock agreements annexed
thereto).
11 Not applicable.
15 Not applicable.
18 Preferability letter from Deloitte & Touche LLP regarding
change in inventory valuation methodology.
19 Not applicable.
22 Not applicable.
23 Not applicable.
24 Not applicable.
31.1 Certification of principal executive officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 302.
31.2 Certification of principal financial officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 302.
32.1 Certification of principal executive officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 906.
32.2 Certification of principal financial officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 906.
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SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: December 3, 2004 FINLAY FINE JEWELRY CORPORATION
By: /s/ Bruce E. Zurlnick
---------------------------------------
Bruce E. Zurlnick
Senior Vice President, Treasurer
and Chief Financial Officer
(As both a duly authorized officer of
Registrant and as principal financial
officer of Registrant)
36