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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 April 30, 2005
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 [ ]
As of June 3, 2005, there were 1,000 shares of common stock, par value $.01 per
share, of the registrant outstanding. As of such date, all shares of common
stock were owned by the registrant's parent, Finlay Enterprises, Inc., a
Delaware corporation.
*The registrant is not subject to the filing requirements of Section 13 or 15(d)
of the Exchange Act and is voluntarily filing this Quarterly Report on Form
10-Q.
FINLAY FINE JEWELRY CORPORATION
FORM 10-Q
QUARTERLY PERIOD ENDED APRIL 30, 2005
INDEX
<TABLE>
PAGE(S)
-------
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Statements of Operations for the thirteen weeks ended
April 30, 2005 and May 1, 2004......................................................1
Consolidated Balance Sheets as of April 30, 2005 and
January 29, 2005....................................................................2
Consolidated Statements of Changes in Stockholder's Equity and
Comprehensive Income (Loss) for the year ended January 29, 2005 and
the thirteen weeks ended April 30, 2005.............................................3
Consolidated Statements of Cash Flows for the thirteen weeks ended
April 30, 2005 and May 1, 2004......................................................4
Notes to Consolidated Financial Statements..........................................5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations......................................15
Item 3. Quantitative and Qualitative Disclosures about Market Risk.........................31
Item 4. Controls and Procedures............................................................31
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds........................33
Item 6. Exhibits...........................................................................33
SIGNATURES.............................................................................................36
</TABLE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
THIRTEEN WEEKS ENDED
-------------------------
MAY 1,
APRIL 30, 2004
2005 (AS RESTATED)
--------- ------------
Sales ............................................ $ 185,729 $ 187,572
Cost of sales .................................... 92,299 91,843
--------- ---------
Gross margin ................................. 93,430 95,729
Selling, general and administrative expenses ..... 88,909 88,181
Depreciation and amortization .................... 4,120 4,389
--------- ---------
Income from operations ....................... 401 3,159
Interest expense, net ............................ 5,068 3,975
--------- ---------
Loss before income taxes ..................... (4,667) (816)
Benefit for income taxes ......................... (1,843) (286)
--------- ---------
Net loss ..................................... $ (2,824) $ (530)
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
1
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
<TABLE>
APRIL 30, JANUARY 29,
2005 2005
--------- -----------
ASSETS
Current assets:
Cash and cash equivalents ......................................... $ 1,099 $ 61,957
Accounts receivable - department stores ........................... 42,350 22,598
Other receivables ................................................. 37,902 35,747
Merchandise inventories ........................................... 295,752 278,589
Prepaid expenses and other ........................................ 5,224 2,958
--------- ---------
Total current assets ........................................... 382,327 401,849
--------- ---------
Fixed assets:
Building, equipment, fixtures and leasehold improvements .......... 113,841 113,039
Less - accumulated depreciation and amortization .................. 53,602 50,558
--------- ---------
Fixed assets, net .............................................. 60,239 62,481
--------- ---------
Deferred charges and other assets, net .............................. 16,017 16,859
Goodwill ............................................................ 77,288 77,288
--------- ---------
Total assets ................................................... $ 535,871 $ 558,477
========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Short-term borrowings ............................................. $ 11,087 $ --
Accounts payable - trade .......................................... 76,318 102,994
Accrued liabilities:
Accrued salaries and benefits .................................. 14,810 14,654
Accrued miscellaneous taxes .................................... 5,754 7,242
Accrued interest ............................................... 7,262 3,120
Deferred income ................................................ 6,984 8,449
Deferred income taxes .......................................... 6,128 6,593
Other .......................................................... 11,677 10,539
Income taxes payable .............................................. 10,329 16,479
Due to parent .................................................... 1,870 1,893
--------- ---------
Total current liabilities ...................................... 152,219 171,963
Long-term debt ...................................................... 200,000 200,000
Deferred income taxes ............................................... 20,850 21,070
Other non-current liabilities ....................................... 523 587
--------- ---------
Total liabilities .............................................. 373,592 393,620
--------- ---------
Commitments and contingencies (see Note 10)
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 ................................................. 79,170 81,994
Accumulated other comprehensive income (loss) ..................... 134 (112)
--------- ---------
Total stockholder's equity ..................................... 162,279 164,857
--------- ---------
Total liabilities and stockholder's equity ..................... $ 535,871 $ 558,477
========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
2
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
ACCUMULATED
COMMON STOCK OTHER
------------------ ADDITIONAL COMPREHENSIVE TOTAL
NUMBER PAID-IN RETAINED INCOME STOCKHOLDER'S COMPREHENSIVE
OF SHARES AMOUNT CAPITAL EARNINGS (LOSS) EQUITY INCOME/(LOSS)
--------- ------ ---------- ---------- ------------- ------------- -------------
Balance, January 31, 2004 ............ 1,000 -- $ 82,975 $ 102,210 $ (85) $ 185,100
Net income ....................... -- -- -- 19,487 -- 19,487 $ 19,487
Change in fair value of gold
forward contracts, net of tax -- -- -- -- (27) (27) (27)
---------
Comprehensive income ............. -- -- -- -- -- -- $ 19,460
=========
Dividends on common stock ........ -- -- (39,703) -- (39,703)
----- -------- --------- -------- --------- -------
Balance, January 29, 2005 ............ 1,000 -- 82,975 81,994 (112) 164,857
Net loss ......................... -- -- -- (2,824) -- (2,824) $ (2,824)
Change in fair value of gold
forward contracts, net of tax -- -- -- -- 246 246 246
---------
Comprehensive loss ............... -- -- -- -- -- -- $ (2,578)
----- -------- --------- -------- --------- ------- =========
Balance, April 30, 2005 .............. 1,000 $ -- $ 82,975 $ 79,170 $ 134 162,279
===== ======== ========= ======== ========= =======
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
(UNAUDITED)
THIRTEEN WEEKS ENDED
----------------------------
MAY 1,
APRIL 30, 2004
2005 (AS RESTATED)
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss .................................................................. $ (2,824) $ (530)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ............................................. 4,120 4,389
Amortization of deferred financing costs .................................. 312 206
Amortization of restricted stock compensation and
restricted stock units ................................................. 235 235
Deferred income tax provision ............................................. (685) 375
Other, net ................................................................ 995 (14)
Changes in operating assets and liabilities:
Increase in accounts and other receivables ............................. (21,907) (22,599)
Increase in merchandise inventories .................................... (17,163) (21,981)
Increase in prepaid expenses and other ................................. (2,266) (2,206)
Decrease in accounts payable and accrued liabilities ................... (46,673) (58,718)
Increase (decrease) in due to parent ................................. (258) 274
--------- ---------
NET CASH USED IN OPERATING ACTIVITIES .............................. (86,114) (100,569)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment, fixtures and leasehold improvements ............... (2,152) (3,120)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES ............................... (2,152) (3,120)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility ................................... 129,277 129,837
Principal payments on revolving credit facility ........................... (118,190) (116,299)
Capitalized financing costs .............................................. (123) --
Bank overdraft ........................................................... 16,444 9,522
Payment of dividends ..................................................... -- (6,862)
--------- ---------
NET CASH PROVIDED FROM FINANCING ACTIVITIES ...................... 27,408 16,198
--------- ---------
DECREASE IN CASH AND CASH EQUIVALENTS ............................ (60,858) (87,491)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .............................. 61,957 89,481
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD .................................... $ 1,099 $ 1,990
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid ........................................................... $ 599 $ 580
========= =========
Income taxes paid ....................................................... $ 5,075 $ 4,345
========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
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 April 30, 2005, and our
results of operations and cash flows for the thirteen weeks ended April 30, 2005
and May 1, 2004. 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 29, 2005 referred to
below. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission (the
"Commission").
These consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto included in our
Annual Report on Form 10-K for the fiscal year ended January 29, 2005 ("Form
10-K") previously filed with the Commission.
Our fiscal year ends on the Saturday closest to January 31. References to
2005, 2004, 2003 and 2002 relate to the fiscal years ending January 28, 2006,
January 29, 2005, January 31, 2004 and February 1, 2003, respectively. Each of
the fiscal years includes 52 weeks.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES: The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements as well as the reported
amounts of revenues and expenses during the reporting period. Significant
estimates include merchandise inventories, vendor allowances, finite-lived
assets, self-insurance reserves, income taxes and other accruals. Actual results
may differ from those estimates.
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. Such contracts typically have durations ranging from one to nine
months. At both April 30, 2005 and January 29, 2005, we had several open
positions in gold forward
5
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
contracts totaling 22,050 fine troy ounces and 37,000 fine troy ounces,
respectively, to purchase gold for $9.6 million and $16.1 million, respectively.
The fair value of gold under such contracts was $9.7 million and $15.8 million
at April 30, 2005 and January 29, 2005, 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.
Vendor allowances have been accounted for in accordance with Emerging
Issues Task Force ("EITF") Issue No. 02-16, "Accounting By a Customer (Including
a Reseller) for Cash Consideration Received from a Vendor" ("EITF 02-16"). 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 April 30, 2005 and January 29, 2005, deferred vendor allowances
totaled (i) $13.1 million and $14.8 million, respectively, for owned
merchandise, which allowances are included as an offset to merchandise
inventories on the Consolidated Balance Sheets, and (ii) $7.0 million and $8.4
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 April 30, 2005, the fair value of the gold forward
contracts resulted in the recognition of an asset of $0.2 million. At January
29, 2005, the fair value of the gold forward contracts resulted in the
recognition of a liability of $0.2 million. The amount recorded in accumulated
other comprehensive income at April 30, 2005 of $0.1 million, net of
6
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
tax, is expected to be reclassified into earnings during 2005. The amount
recorded in accumulated other comprehensive loss at January 29, 2005 of $0.1
million, net of tax, was reclassified into earnings in the first quarter of
2005.
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 also assess, 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.
FAIR VALUE OF FINANCIAL INSTRUMENTS: Cash, accounts receivable, short-term
borrowings, accounts payable and accrued liabilities are reflected in the
Consolidated Financial Statements at fair value due to the short-term maturity
of these instruments.
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:
<TABLE>
THIRTEEN WEEKS ENDED
-------------------------
MAY 1,
APRIL 30, 2004
2005 (AS RESTATED)
-------- -------------
(IN THOUSANDS)
Reported net loss ......................................... $(2,824) $ (530)
Add: Stock-based employee compensation expense
determined under the fair value method, net of tax.... (224) (253)
Deduct: Stock-based employee compensation expense
included in reported net loss, net of tax ............ 190 174
------- -------
Pro forma net loss ........................................ $(2,858) $ (609)
======= =======
</TABLE>
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for
Stock-Based Compensation". This Statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS 123(R) requires that the fair value of such equity
instruments be recognized as expense in the historical financial statements as
services are performed. Currently, only certain pro forma disclosures of fair
value are required. Although we are in the process of determining the impact of
this Statement on our results of operations, the historical impact for the
thirteen weeks ended April 30, 2005 and May 1, 2004, respectively, under SFAS
No. 123 is shown in the table above.
7
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In March 2005, the Commission issued Staff Accounting Bulletin ("SAB") No.
107 "Share-Based Payment." SAB No. 107 expresses views of the Commission staff
regarding the interaction between SFAS No. 123(R) and certain Commission rules
and regulations and provide the staff's views regarding the valuation of
share-based payment arrangements. Subsequently, the Commission decided to delay
the required implementation of SFAS No. 123(R) to years beginning after June 15,
2005. We will adopt SFAS No. 123(R) for the first quarter of fiscal 2006.
NOTE 3 - DESCRIPTION OF BUSINESS
We are a retailer of fine jewelry products and operate licensed fine
jewelry departments in department stores throughout the United States. The
fourth quarter of 2004 accounted for approximately 41% of our sales and
approximately 90% of our income from operations, due to the seasonality of the
retail jewelry industry. During 2004, store groups owned by The May Department
Stores Company ("May") and Federated Department Stores, Inc. ("Federated")
accounted for 59% (including Marshall Field's for the 2004 fiscal year) and 19%,
respectively, of our sales.
NOTE 4 - SHORT AND LONG-TERM DEBT
On January 22, 2003, our revolving credit agreement with General Electric
Capital Corporation ("GECC") 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 April 30,
2005, $11.1 million was outstanding under this facility, at which point the
available borrowings were $192.7 million. The average amounts outstanding under
the Revolving Credit Agreement were $11.8 million and $10.3 million for the
thirteen weeks ended April 30, 2005 and May 1, 2004, respectively. The maximum
amount outstanding for the thirteen weeks ended April 30, 2005 was $32.6
million, at which point the available borrowings were an additional $174.3
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 6.1% and 4.2% for the thirteen weeks ended April 30,
2005 and May 1, 2004, respectively.
During 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.
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. Additionally,
during 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 and commenced on December 1, 2004.
We incurred approximately $5.2 million in costs, including $5.0 million
associated with the sale of the New Senior Notes, which have been deferred and
are being amortized over the term of the New
8
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - SHORT AND LONG-TERM DEBT (CONTINUED)
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.
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 (a)
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, to (b) 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.
NOTE 5 - MERCHANDISE INVENTORIES
Merchandise inventories consisted of the following:
APRIL 30, JANUARY 29,
2005 2005
-------- -----------
(IN THOUSANDS)
Jewelry goods - rings, watches and other fine jewelry
(first-in, first-out ("FIFO") basis) .......... $314,832 $297,266
Less: Excess of FIFO cost over LIFO inventory value 19,080 18,677
-------- --------
$295,752 $278,589
======== ========
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 method that is preferable under the circumstances
described above. The LIFO charge for the thirteen weeks ended April 30, 2005 was
approximately $0.4 million. The net loss for the thirteen weeks ended May 1,
2004 has been restated to reflect this change in accordance with SFAS No. 3,
"Reporting Accounting Changes in Interim Financial Statements". Under the new
accounting method, the LIFO charge for the thirteen weeks ended May 1, 2004, was
approximately $0.3
9
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - MERCHANDISE INVENTORIES (CONTINUED)
million compared to $0.8 million, as previously reported. The following table
presents the net loss for the thirteen weeks ended May 1, 2004, as restated:
THIRTEEN WEEKS
ENDED
MAY 1, 2004
--------------
(IN THOUSANDS)
NET LOSS:
Net loss, as previously reported ........... $(830)
Impact of change in LIFO inventory valuation
method, net of tax .................... 300
-----
Net loss, as restated ...................... $(530)
=====
Approximately $358.9 million and $349.7 million at April 30, 2005 and
January 29, 2005, respectively, of merchandise received on consignment is not
included in merchandise inventories and accounts payable-trade in the
accompanying Consolidated Balance Sheets.
We are a party to an amended and restated gold consignment agreement (as
amended, the "Gold Consignment Agreement"), which enables us to receive
consignment merchandise by providing gold, or otherwise making payment, to
certain vendors. While the merchandise involved remains consigned, title to the
gold content of the merchandise transfers from the vendors to the gold
consignor.
Our Gold Consignment Agreement matures on July 31, 2005, and permits us to
consign up to the lesser of (i) 165,000 fine troy ounces or (ii) $50.0 million
worth of gold, subject to a formula as prescribed by the Gold Consignment
Agreement. We are currently in the process of extending the term of the Gold
Consignment Agreement. 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 April 30, 2005 and January 29, 2005,
amounts outstanding under the Gold Consignment Agreement totaled 113,892 and
116,687 fine troy ounces, respectively, valued at $49.6 million and $49.8
million, respectively. In the event this agreement is terminated, Finlay Jewelry
will be required to return the gold or purchase the outstanding gold at the
prevailing gold rate in effect on that date. For financial statement purposes,
the consigned gold is not included in merchandise inventories on the
Consolidated Balance Sheets and, therefore, no related liability has been
recorded.
NOTE 6 - LICENSE AGREEMENTS WITH DEPARTMENT STORES AND LEASE
AGREEMENTS
We conduct the majority of our operations as licensed departments in
department stores. All of the department store licenses provide that, except
under limited circumstances, the title to certain of our fixed assets transfers
upon termination of the licenses, and that we will receive certain
reimbursements for the undepreciated value of such fixed assets from the host
store in the event such transfers occur. The value of such fixed assets are
recorded at the inception of the license arrangement and are reflected in the
accompanying Consolidated Balance Sheets.
In several cases, we are subject to limitations under our license
agreements with host department stores which prohibit us from operating
departments for other store groups within a certain geographical radius of the
host store.
10
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - LICENSE AGREEMENTS WITH DEPARTMENT STORES AND LEASE
AGREEMENTS (CONTINUED)
The department store license agreements provide for the payment of fees
based on sales (i.e., contingent fees in the table below), plus, in some
instances, installment payments for fixed assets. Our operating leases consist
primarily of office space rentals and these expire on various dates through
2008. Minimum fees, in the table below, represent the rent paid on these
operating leases. License fees and lease expense, included in Selling, general
and administrative expenses, are as follows (in thousands):
THIRTEEN WEEKS ENDED
--------------------
APRIL 30, MAY 1,
2005 2004
-------- -------
(IN THOUSANDS)
Minimum fees .. $ 1,942 $ 2,028
Contingent fees 29,674 29,768
------- -------
Total ....... $31,616 $31,796
======= =======
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. As of April 30, 2005, and from inception of the
program, the Holding Company has repurchased a total of 2,207,904 shares for
$27.4 million.
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 became
fully vested on January 29, 2005 and was accounted for as a component of the
Holding Company's stockholders' equity. Compensation expense of approximately
$1.2 million has been amortized over four years and totaled approximately
$76,000 for the thirteen weeks ended May 1, 2004.
In August 2003, an executive officer of Finlay was issued an additional
50,000 shares of Restricted Stock, pursuant to a restricted stock agreement.
Fifty percent of the Restricted Stock became fully vested on January 29, 2005,
and was accounted for as a component of the Holding Company's stockholders'
equity. Compensation expense of approximately $0.4 million has been amortized
over the vesting period and totaled approximately $66,000 for the thirteen weeks
ended May 1, 2004. The remaining 50% of the Restricted Stock becomes fully
vested on June 30, 2007 and has been accounted for as a component of the Holding
Company stockholders' equity. Compensation expense of approximately $0.4 million
is being amortized over the vesting period and totaled approximately $25,000 for
each of the thirteen week periods ended April 30, 2005 and May 1, 2004.
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
11
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - LONG -TERM INCENTIVE PLANS AND OTHER (CONTINUED)
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 $0.5 million is being amortized over four
years and totaled approximately $30,000 for each of the thirteen week periods
ended April 30, 2005 and May 1, 2004.
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 $0.6 million is being amortized over two years and totaled
approximately $78,000 for the thirteen weeks ended April 30, 2005.
In April 2005, certain executives of the Company were awarded a total of
46,800 shares of Restricted Stock, pursuant to restricted stock agreements. The
Restricted Stock becomes fully vested after three 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 $0.6 million is being amortized over three years.
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 credits 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 April 30, 2005, 190,004 restricted
stock units have been awarded under the RSU Plans. Amortization for the thirteen
weeks ended April 30, 2005 and May 1, 2004 totaled approximately $0.1 million
and $40,000, respectively.
12
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 two departments during the thirteen weeks ended April 30, 2005. For
the thirteen weeks ended April 30, 2005 and May 1, 2004, we recorded charges of
approximately $33,000 and $0.4 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 arising out of our
operations in the normal course of business. As of June 3, 2005, we are not a
party to any legal proceedings that, individually or in the aggregate, are
reasonably expected to have a material adverse effect on our 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.
In November 2004, we entered into a new employment agreement with a senior
executive. The new employment agreement has a term of four years commencing on
January 30, 2005 and ending on January 31, 2009, unless earlier terminated in
accordance with the provisions of the employment agreement. The agreement
provides an annual salary level of approximately $1.0 million as well as
incentive compensation based on meeting specific financial goals.
The New Senior Notes, the Revolving Credit Agreement and the Gold
Consignment Agreement currently restrict the amount of annual distributions to
the Holding Company, including those required to fund stock repurchases.
Our concentration of credit risk consists principally of accounts
receivable. Over the past three years, store groups owned by May and Federated
accounted for 54% (including Marshall Field's for the 2004 fiscal year) and 18%,
respectively, of our sales. We believe that the risk associated with these
receivables, other than those from department store groups indicated above,
would not have a material adverse effect on our financial position or results of
operations.
On February 28, 2005, Federated and May announced that they have entered
into a merger agreement whereby Federated would acquire May. The transaction is
expected to close in the third quarter of 2005. The completion of the merger is
contingent upon regulatory review and approval by the shareholders of both
companies. Finlay's license agreements with May are terminable at various dates
over the next three years. Finlay's license agreements with Federated are
terminable at various dates over the next two years. There is no assurance that
our host store relationships with May and Federated or future results of
operations will not be adversely impacted as a result of this transaction.
We have not provided any third-party financial guarantees as of April 30,
2005 and January 29, 2005.
13
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - SUBSEQUENT EVENT
On May 19, 2005, we signed a definitive merger agreement and closed the
previously announced acquisition of Carlyle & Co. Jewelers ("Carlyle"). The
purchase price was approximately $29.0 million and was financed with additional
borrowings under our Revolving Credit Agreement. Founded in North Carolina in
1922, Carlyle is located primarily in the southeastern United States, with 34
specialty jewelry stores operating under the Carlyle & Co., J.E. Caldwell & Co.
and Park Promenade trade names and had annual sales of $86.0 million during its
last fiscal year. The Carlyle subsidiaries will operate as a separate division
of Finlay Jewelry.
In Carlyle's most recent fiscal year, average borrowings under their
revolving credit facility were approximately $20.0 million. This facility was
terminated and paid in full at the closing and Carlyle's cash requirements going
forward will be funded under Finlay's Revolving Credit Agreement. In connection
with the acquisition, we replaced the existing Revolving Credit Agreement and
entered into an amended and restated credit agreement (the "Restated Credit
Agreement") with GECC and certain other lenders and we entered into a consent
and amendment to the Gold Consignment Agreement (the "Gold Consignment
Amendment"), to, among other things, permit the acquisition transaction. In
addition, Carlyle and its subsidiaries, together with us, entered into
supplemental indentures and guarantees (the "Supplemental Indentures") to
guarantee our obligations under the New Senior Notes.
14
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, risks and
uncertainties that we focus on in the operation of our business.
o RESULTS OF OPERATIONS - This section provides an analysis of the
significant line items on the consolidated statements of operations.
o LIQUIDITY AND CAPITAL RESOURCES - This section provides an analysis of
liquidity, cash flows, sources and uses of cash, contractual
obligations and financial position.
o SEASONALITY - This section describes the effects of seasonality on our
business.
o CRITICAL ACCOUNTING POLICIES AND ESTIMATES - This section discusses
those accounting policies that are considered both 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 FORWARD-LOOKING INFORMATION AND RISK FACTORS THAT MAY AFFECT FUTURE
RESULTS - This section provides cautionary information about
forward-looking statements and a description of certain risks and
uncertainties that could cause actual results to differ materially
from our historical results or current expectations or projections.
On May 19, 2005, we signed a definitive merger agreement and closed the
previously announced acquisition of Carlyle. The purchase price was
approximately $29.0 million and was financed with additional borrowings under
our Revolving Credit Agreement. Founded in North Carolina in 1922, Carlyle is
located primarily in the southeastern United States, with 34 specialty jewelry
stores and annual sales of $86.0 million during its last fiscal year. Unless
otherwise indicated, the following discussion excludes Carlyle, as the
acquisition closed subsequent to April 30, 2005.
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 $201 per item. As of April
30, 2005, we operated 962 locations in 16 host store groups, in 46 states and
the District of Columbia.
Our primary focus is to offer desirable and competitively priced products,
a breadth of merchandise assortments and to provide exceptional customer
service. Our ability to quickly identify emerging trends and maintain strong
relationships with vendors has enabled us to present superior assortments in our
showcases. We believe that we are an important contributor to each of our host
store groups and we
15
continue to seek opportunities to penetrate the department store segment. By
outsourcing their fine jewelry departments to us, host store groups gain our
expertise in merchandising, selling and marketing jewelry and customer service.
Additionally, by avoiding high working capital investments typically required of
the traditional retail jewelry business, host stores improve their return on
investment and increase their profitability. As a licensee, we benefit from the
host stores' reputation, customer traffic, credit services and established
customer base. We also avoid the substantial capital investment in fixed assets
typical of a stand-alone retail format. In recent years, on average,
approximately 50% of our merchandise has been carried on consignment, which
reduces our inventory exposure to changing fashion trends. These factors have
generally led our new departments to achieve profitability within the first
twelve months of operation.
We measure ourselves against key financial measures that we believe provide
a well-balanced perspective regarding our overall financial success. Those
benchmarks are as follows, together with how they are computed:
o Comparable department sales growth computed as the percentage change
in sales for departments open for the same months during the
comparable periods. Comparable department sales are measured against
our host store groups as well as other jewelry retailers;
o Total net sales growth (current period total net sales minus prior
period total net sales divided by prior period total net sales equals
percentage change) which indicates, among other things, the success of
our selection of new store locations and the effectiveness of our
merchandising strategies; and
o Operating margin rate (income from operations divided by net sales)
which is an indicator of our success in leveraging our fixed costs and
managing our variable costs. Key components of income from operations
which management focuses on, include monitoring gross margin levels as
well as continued emphasis on leveraging our SG&A.
FIRST QUARTER HIGHLIGHTS
Total sales were $185.7 million for the thirteen weeks ended April 30, 2005
compared to $187.6 million for the thirteen weeks ended May 1, 2004, a decrease
of 1.0%. Comparable department sales increased 0.5%. Gross margin decreased by
$2.3 million compared to 2004, and as a percentage of sales, gross margin
decreased by 0.7% from 51.0% to 50.3%. SG&A increased $0.7 million and as a
percentage of sales, SG&A increased 0.9% from 47.0% to 47.9%. Borrowings under
the Revolving Credit Agreement decreased slightly by $2.5 million at April 30,
2005 as compared to May 1, 2004. Maximum outstanding borrowings during the
thirteen weeks ended April 30, 2005 were $32.6 million, at which point the
available borrowings under the Revolving Credit Agreement were an additional
$174.3 million.
OPPORTUNITIES
We believe that current trends in jewelry retailing provide a significant
opportunity for our future growth. Consumers spent approximately $57.0 billion
on jewelry (including both fine jewelry and costume jewelry) in the United
States in calendar year 2004, an increase of approximately $21.0 billion over
1994, according to the United States Department of Commerce. In the department
store sector in which we operate, consumers spent an estimated $4.1 billion on
fine jewelry in calendar year 2003. Our management believes that demographic
factors such as the maturing U.S. population and an increase in the number of
working women, have resulted in greater disposable income, thus contributing to
the growth of the fine jewelry retailing industry. Our management also believes
that jewelry consumers
16
today increasingly perceive fine jewelry as a fashion accessory, resulting in
purchases which augment our gift and special occasion sales.
An important initiative and focus of management is developing opportunities
for our growth. We consider it a high priority to identify new businesses that
offer growth, financial viability and manageability and will have a positive
impact on shareholder value. As discussed above, we completed the acquisition of
Carlyle on May 19, 2005.
In 2004, we tested moissanite merchandise (moissanite is a lab-created
stone with greater brilliance and luster than a diamond) in certain departments.
This new category of merchandise will be expanded to additional departments
during 2005 and is estimated to generate sales of $10-$15 million on a annual
basis.
Additional growth opportunities exist with respect to opening departments
within existing host store groups that do not currently operate jewelry
departments. Such opportunities exist within Dillard's and Belk's. During 2003
and 2004, we added a total of 24 new departments in Dillard's and Belks and plan
to add seven more departments within these host store groups during 2005.
Since November 2003, we have been selling fine jewelry on the SmartBargains
internet site and fulfilling this e-business through our distribution center.
Sales generated during 2004 totaled approximately $8.0 million. We will continue
to seek to identify complementary businesses to leverage our core competencies
in the jewelry industry.
We continue to seek growth opportunities and plan to continue to pursue the
following key initiatives to further increase sales and earnings:
o Increase comparable department sales;
o Add departments within existing host store groups;
o Add new stores to the Carlyle division;
o Expand our most productive departments;
o Identify and acquire new businesses;
o Open new channels of distribution;
o Introduce new fashion trends;
o Add new host store relationships;
o Continue to raise customer service standards;
o Strengthen selling teams through training programs;
o Continue to improve operating leverage; and
o De-leverage the balance sheet.
17
RISKS AND UNCERTAINTIES
The risks and challenges facing our business include:
o Host store consolidation; and
o Dependence on or loss of certain host store relationships.
During 2004, approximately 59% (including Marshall Field's for the 2004
fiscal year) and 19% of our sales were generated by departments operated in
store groups owned by May and Federated, respectively. We have operated
departments with May since 1948 and with Federated since 1983. We believe that
our relationships with these host stores are excellent. Nevertheless, a decision
by either company, or certain of our other host store groups, to terminate
existing relationships, to assume the operation of those departments themselves,
or to close significant number of stores would have a material adverse effect on
our business and financial condition.
On February 28, 2005, Federated and May announced that they have entered into
a merger agreement whereby Federated would acquire May. The transaction is
expected to close in the third quarter of 2005. The completion of the merger is
contingent upon regulatory review and approval by the shareholders of both
companies. Finlay's license agreements with May are terminable as follows:
Robinsons-May/Meier & Frank, Filene's/Kaufmann's and Famous Barr/L.S.
Ayres/Jones on January 28, 2006, Foley's, Hecht's/Strawbridge's and Lord &
Taylor on February 3, 2007 and Marshall Field's on April 2, 2008. Finlay's
license agreements with Federated are terminable as follows:
Rich's-Macy's/Lazarus-Macy's/Goldsmith's-Macy's and Bon-Macy's on January 28,
2006 and Bloomingdale's on February 3, 2007. We cannot anticipate the impact of
the proposed transaction on our future results of operations and there is no
assurance that we will not be adversely impacted.
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 two departments during
the thirteen weeks ended April 30, 2005. Through April 30, 2005, a total of 29
stores have closed.
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
<TABLE>
THIRTEEN WEEKS ENDED
----------------------------
MAY 1,
APRIL 30, 2004
2005 (AS RESTATED)
----------- -----------
Sales................................................ 100.0% 100.0%
Cost of sales........................................ 49.7 49.0
----------- -----------
Gross margin..................................... 50.3 51.0
Selling, general and administrative expenses......... 47.9 47.0
Depreciation and amortization........................ 2.2 2.3
----------- -----------
Income from operations........................... 0.2 1.7
Interest expense, net................................ 2.7 2.1
----------- -----------
Loss before income taxes......................... (2.5) (0.4)
Benefit for income taxes............................. (1.0) (0.1)
----------- -----------
Net loss......................................... (1.5)% (0.3)%
=========== ===========
</TABLE>
18
THIRTEEN WEEKS ENDED APRIL 30, 2005 COMPARED WITH THIRTEEN WEEKS ENDED MAY 1,
2004
SALES. Sales for the thirteen weeks ended April 30, 2005 decreased $1.8
million, or 1.0%, over the comparable period in 2004. Comparable department
sales (departments open for the same months during the comparable periods)
increased 0.5%. We attribute the decrease in sales primarily to the continued
challenging retail environment.
During the thirteen weeks ended April 30, 2005, we opened four departments,
including two departments in Dillard's and closed four departments. The openings
and closings were all within existing store groups.
GROSS MARGIN. Gross margin decreased by $2.3 million in 2005 compared to
2004, and, as a percentage of sales, gross margin decreased by 0.7%. The
components of this 0.7% net decrease in gross margin are as follows:
COMPONENT % REASON
--------------------------------- ---------- --------------------------------
Merchandise cost of sales........ (0.4)% Increase in merchandise cost of
sales is due to our continued
efforts to increase market
penetration and market share
through our pricing strategy,
the mix of sales with increased
sales in the diamond, designer
and clearance categories which
have lower margins than other
categories, as well as the
increased price of gold.
Other ........................... (0.3)% Increase in other cost of sales
is due to the net increase in
various other components of cost
of sales.
----
Total .............. (0.7)%
====
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The components of SG&A
include payroll expense, license fees, net advertising expenditures and other
field and administrative expenses. SG&A increased $0.7 million, or 0.8%. As a
percentage of sales, SG&A increased by 0.9%. The components of this 0.9% net
increase in SG&A are as follows:
COMPONENT % REASON
- ---------------------------------- --------- --------------------------------
Net advertising expenditures...... 0.4 Decrease is due to lower gross
advertising expenditures and
increased vendor support.
Payroll and other expenses........ (1.3) The increase in payroll and
other expenses is due to lower
than expected same store sales
negatively impacting the
leveraging of these expenses.
----
Total ........... (0.9)%
====
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased by
$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.
INTEREST EXPENSE, NET. Interest expense increased by $1.1 million
primarily due to an increase in average borrowings ($211.8 million for the
period in 2005 compared to $160.3 million for the comparable period in 2004) 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 8.3% for the 2005 period compared to 8.1% for the comparable
period in 2004.
19
BENEFIT FOR INCOME TAXES. The income tax benefit for the 2005 and 2004
periods reflects effective tax rates of 39.5% and 39.0%, respectively.
NET LOSS. Net loss of $2.8 million for the 2005 period, represents an
increased loss of $2.3 million as compared to the net loss of $0.5 million in
the prior period as a result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Information about our financial position as of April 30, 2005 and January
29, 2005 is presented in the following table:
APRIL 30, JANUARY 29,
2005 2005
--------- -----------
(DOLLARS IN THOUSANDS)
Cash and cash equivalents $ 1,099 $ 61,957
Working capital ......... 230,108 229,886
Long-term debt .......... 200,000 200,000
Stockholder's equity .... 162,279 164,857
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 license fees to host store groups, and, to a lesser extent,
capital expenditures for opening new departments, renovating existing
departments and information technology investments. For 2004, capital
expenditures totaled $12.7 million and for 2005 are estimated to be
approximately $10 to $12 million, excluding any impact from the Carlyle
acquisition. Although capital expenditures are limited by the terms of the
Revolving Credit Agreement, to date, this limitation has not precluded us from
satisfying our capital expenditure requirements.
We currently expect to fund capital expenditure requirements as well as
liquidity needs from a combination of cash, internally generated funds and
borrowings under our Revolving Credit Agreement. We believe that our internally
generated liquidity through cash flows from operations, together with access to
external capital resources, will be sufficient to satisfy existing commitments
and plans and will provide adequate financing flexibility.
Cash flows provided from (used in) operating, investing and financing
activities for the thirteen weeks ended April 30, 2005 and May 1, 2004 were as
follows:
THIRTEEN WEEKS ENDED
---------------------------------
MAY 1,
APRIL 30, 2004
2005 (AS RESTATED)
--------------- --------------
(DOLLARS IN THOUSANDS)
Operating activities ............. $ (86,114) $(100,569)
Investing activities ............. (2,152) (3,120)
Financing activities ............. 27,408 16,198
--------- ---------
Net decrease in cash and cash
equivalents ............ $ (60,858) $ (87,491)
========= =========
20
Our current priorities for the use of cash or borrowings, as a result of
borrowings available under the Revolving Credit Agreement, are:
o Investment in inventory and for working capital;
o Capital expenditures for new departments, expansions and remodeling of
existing departments;
o Investments in technology; and
o Strategic acquisitions.
OPERATING ACTIVITIES
The primary source of our liquidity is cash flows from operating
activities. The key component of operating cash flow is merchandise sales.
Operating cash outflows include payments to vendors for inventory, services and
supplies, payments for employee payroll, license fees and payments of interest
and taxes. Net cash flows used in operating activities were $86.1 million and
$100.6 million for the thirteen weeks ended April 30, 2005 and May 1, 2004,
respectively.
Our operations substantially preclude customer receivables as our license
agreements require host stores to remit sales proceeds for each month (without
regard to whether such sales were cash, store credit or national credit card) to
us approximately three weeks after the end of such month. However, we cannot
ensure the collection of sales proceeds from our host stores. Additionally, on
average, approximately 50% of our merchandise has been carried on consignment.
Our working capital balance was $230.1 million at April 30, 2005, an increase of
$0.2 million from January 29, 2005.
The seasonality of our business causes working capital requirements, and
therefore, borrowings under the Revolving Credit Agreement, to reach their
highest level in the months of October, November and December in anticipation of
the year-end holiday season. Accordingly, we experience seasonal cash needs as
inventory levels peak. Additionally, substantially all of our license agreements
provide for accelerated payments during the months of November and December,
which require the host store groups to remit to us 75% of the estimated months'
sales prior to or shortly following the end of that month. These proceeds result
in a significant increase in our cash, which is used to reduce our borrowings
under the Revolving Credit Agreement. Inventory levels increased by $17.2
million, or 6.2%, as compared to. January 29, 2005 as a result of the seasonal
increase in inventory for the Mother's Day period.
INVESTING ACTIVITIES
Net cash used in investing activities, consisting of payments for capital
expenditures, was $2.2 million and $3.1 million for the thirteen weeks ended
April 30, 2005 and May 1, 2004, 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
have been our primary financing activities. Net cash provided from financing
activities was $27.4 million for the thirteen weeks ended April 30, 2005,
consisting principally of proceeds from, and principal payments on, the
Revolving Credit Facility. Net cash provided from financing activities was $16.2
million for the thirteen weeks ended May 1, 2004.
21
Our Revolving Credit Agreement, which expires in January 2008, provides us
with a line of credit of up to $225.0 million to finance working capital needs.
Amounts outstanding under the Revolving Credit Agreement bear interest at a rate
equal to, at our option, (i) the prime rate plus a margin ranging from zero to
1.0% or (ii) the adjusted Eurodollar rate plus a margin ranging from 1.0% to
2.0%, in each case depending on our financial performance. The weighted average
interest rate was 6.1% and 4.2% for the thirteen weeks ended April 30, 2005 and
May 1, 2004, 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 $11.1 million at April 30, 2005, compared to
a zero balance at January 29, 2005 and $13.5 million at May 1, 2004. The average
amounts outstanding under the Revolving Credit Agreement were $11.8 million and
$10.3 million for the thirteen weeks ended April 30, 2005 and May 1, 2004,
respectively. The maximum amount outstanding for the thirteen weeks ended April
30, 2005 was $32.6 million, at which point the available borrowings were an
additional $174.3 million.
On May 19, 2005, we signed a definitive merger agreement and closed the
previously announced acquisition of Carlyle. The purchase price was
approximately $29.0 million and was financed with additional borrowings under
the Revolving Credit Agreement. In Carlyle's most recent fiscal year, average
borrowings under their revolving credit facility were approximately $20.0
million. This facility was terminated and paid in full at the closing and
Carlyle's cash requirements going forward will be funded under our Revolving
Credit Agreement. As a result of the acquisition of Carlyle, we anticipate that
borrowings under our Revolving Credit Agreement will increase by approximately
$50.0 million over last year. In connection with the acquisition, we replaced
the existing Revolving Credit Agreement and entered into the Restated Credit
Agreement with GECC and certain other lenders and we entered into the Gold
Consignment Amendment, to, among other things, permit the acquisition
transaction. In addition, Carlyle and its subsidiaries, together with us,
entered into the Supplemental Indenture to guarantee our obligations under the
New Senior Notes.
During 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. 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. Additionally, during 2004, we completed the sale of the New
Senior Notes. Interest on the New Senior Notes is payable semi-annually on June
1 and December 1 of each year and commenced on December 1, 2004.
The tender offers, New Senior Notes offering and redemptions of the
outstanding Senior Notes and Senior Debentures were all undertaken to decrease
our overall interest rate, extend our debt maturities and decrease total
long-term debt as well as simplify our capital structure by eliminating debt at
the parent company level. As a result of the completion of the redemption of the
Senior Debentures, we are no longer required to provide the funds necessary to
pay the higher debt service costs associated with the Senior Debentures.
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
needed 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 April 30, 2005, our outstanding borrowings
were $211.1 million,
22
which included a $200.0 million balance under the New Senior Notes and $11.1
million balance under the Revolving Credit Agreement, compared to $238.5 million
as of May 1, 2004.
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 thirteen weeks ended April
30, 2005, we are in compliance with all of our covenants. We expect to be in
compliance with all of our covenants through 2005. Because compliance is based,
in part, on our management's estimates and actual results can differ from those
estimates, there can be no assurance that we will be in compliance with the
covenants in the future or that the lenders will waive or amend any of the
covenants should we be in violation thereof. We believe the assumptions used are
appropriate.
The Revolving Credit Agreement contains customary covenants, including
limitations on, or relating to, capital expenditures, liens, indebtedness,
investments, mergers, acquisitions, affiliate transactions, management
compensation and the payment of dividends and other restricted payments. The
Revolving Credit Agreement also contains various financial covenants, including
minimum earnings and fixed charge coverage ratio requirements and certain
maximum debt limitations.
The indenture related to the New Senior Notes contains restrictions
relating to, among other things, the payment of dividends, redemptions or
repurchases of capital stock, the incurrence of additional indebtedness, the
making of certain investments, the creation of certain liens, the sale of
certain assets, entering into transactions with affiliates, engaging in mergers
and consolidations and the transfer of all or substantially all assets.
We believe that, based upon current operations, anticipated growth and
continued availability under the Revolving Credit Agreement, we will, for the
foreseeable future, be able to meet our debt service and anticipated working
capital obligations, and to make distributions to the Holding Company sufficient
to permit the Holding Company to pay certain expenses as they come due. No
assurances, however, can be given that our current level of operating results
will continue or improve or that our income from operations will continue to be
sufficient to permit us to meet our debt service and other obligations.
Currently, our principal financing arrangements restrict the amount of annual
distributions to the Holding Company, including those required to fund stock
repurchases. The amounts required to satisfy the aggregate of our interest
expense totaled $0.6 million for each of the thirteen week periods ended April
30, 2005 and May 1, 2004.
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 April 30, 2005, $358.9 million
of consignment merchandise from approximately 300 vendors was on hand as
compared to $370.3 million at May 1, 2004. For 2004, we had an average balance
of consignment merchandise of $365.2 million.
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 April 30, 2005 (dollars in thousands):
23
<TABLE>
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 ..... 125,625 16,750 33,500 33,500 41,875
Operating lease obligations (2) ........... 7,054 1,942 3,834 1,278 --
Revolving Credit Agreement (due 2008) (3) . 11,087 11,087 -- -- --
Gold Consignment Agreement (expires 2005) . 49,623 49,623 -- -- --
Gold forward contracts .................... 9,574 9,574 -- -- --
Employment agreement (expires 2008) ....... 3,750 750 2,000 1,000 --
Letters of credit ......................... 12,590 12,340 -- 250 --
-------- -------- -------- -------- --------
Total .................................. $419,303 $102,066 $ 39,334 $ 36,028 $241,875
======== ======== ======== ======== ========
</TABLE>
- ---------------
(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 29, 2005.
(3) The outstanding balance under the Revolving Credit Agreement at June 3,
2005 was $105.5 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 April 30, 2005, other than as disclosed in the table above,
nor have we provided any third-party financial guarantees as of and for the
thirteen weeks ended April 30, 2005.
OFF-BALANCE SHEET ARRANGEMENTS
Our Gold Consignment Agreement enables us to receive consignment
merchandise by providing gold, or otherwise making payment, to certain vendors.
While the merchandise involved remains consigned, title to the gold content of
the merchandise transfers from the vendors to the gold consignor. The Gold
Consignment Agreement matures on July 31, 2005 and permits us to consign up to
the lesser of (i) 165,000 fine troy ounces or (ii) $50.0 million worth of gold,
subject to a formula as prescribed by the Gold Consignment Agreement. We are
currently in the process of extending the term of the Gold Consignment
Agreement. At April 30, 2005, amounts outstanding under the Gold Consignment
Agreement totaled 113,892 fine troy ounces, valued at $49.6 million. The average
amount outstanding under the Gold Consignment Agreement was $48.9 million in
2004. In the event this agreement is terminated, we would be required to return
the gold or purchase the outstanding gold at the prevailing gold rate in effect
on that date. For financial statement purposes, the consigned gold is not
included in merchandise inventories on the Consolidated Balance Sheets and,
therefore, no related liability has been recorded.
The Gold Consignment Agreement requires us to comply with certain
covenants, including restrictions on the incurrence of certain indebtedness, the
creation of liens, engaging in transactions with affiliates and limitations on
the payment of dividends. In addition, the Gold Consignment Agreement also
contains various financial covenants, including minimum earnings and fixed
charge coverage ratio requirements and certain maximum debt limitations. At
April 30, 2005, we were in compliance with all of our covenants under the Gold
Consignment Agreement.
We have not created, and are not party to, any off-balance sheet entities
for the purpose of raising capital, incurring debt or operating our business. We
do not have any arrangements or relationships with entities that are not
consolidated into the financial statements that are reasonably likely to
materially affect our liquidity or the availability of capital resources.
24
OTHER ACTIVITIES AFFECTING LIQUIDITY
In November 2004, we entered into a new employment agreement with a senior
executive. The new employment agreement has a term of four years commencing on
January 30, 2005 and ending on January 31, 2009, unless earlier terminated in
accordance with the provisions of the employment agreement. The agreement
provides an annual salary level of approximately $1.0 million as well as
incentive compensation based on meeting specific financial goals.
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 April 30, 2005, we had several open positions
in gold forward contracts totaling 22,050 fine troy ounces, to purchase gold for
$9.6 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.
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 2004 accounted
for approximately 41% of our sales and approximately 90% 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.
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
periodically re-evaluated, as appropriate, 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 29, 2005.
MERCHANDISE INVENTORIES
We value our inventories at the lower of cost or market. The cost is
determined by the LIFO method utilizing an internally generated index. 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,
25
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.
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 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
26
differing treatment of income or expense items for tax and accounting purposes.
We establish tax reserves in our consolidated financial statements based on our
estimation of current tax exposures. If we prevail in tax matters for which
reserves have been established or if we are required to settle matters in excess
of established reserves, the effective tax rate for a particular period could be
materially affected.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for
Stock-Based Compensation". This Statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS 123(R) requires that the fair value of such equity
instruments be recognized as expense in the historical financial statements as
services are performed. Currently, only certain pro forma disclosures of fair
value are required. Although we are in the process of determining the impact of
this Statement on our results of operations, the historical impact under SFAS
No. 123 "Accounting for Stock-Based Compensation" is disclosed in Note 2 to the
Consolidated Financial Statements.
In March 2005 the Commission issued Staff Accounting Bulletin ("SAB") No.
107 "Share-Based Payment." SAB No. 107 expresses views of the Commission staff
regarding the interaction between SFAS No. 123(R) and certain Commission rules
and regulations and provide the staff's views regarding the valuation of
share-based payment arrangements. Subsequently the Commission decided to delay
the required implementation of SFAS No. 123(R) to years beginning after June 15,
2005. We will adopt SFAS No. 123(R) for the first quarter of fiscal 2006.
FORWARD-LOOKING INFORMATION AND RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
This Form 10-Q includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 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:
OUR SALES DEPEND UPON OUR HOST STORE RELATIONSHIPS. THE LOSS OF
RELATIONSHIPS WITH MAY OR FEDERATED, OR SIGNIFICANT STORE CLOSURES BY OUR HOST
STORE GROUPS, COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS.
The impact of the recently announced planned merger of May and Federated
is unknown. A decision by them, or certain of our other host store groups, to
terminate existing relationships, transfer the operation of some or all of their
departments to a competitor, assume the operation of those departments
themselves, or close a significant number of stores, could have a material
adverse effect on our business and financial condition. During 2004,
approximately 78% of our sales were generated by departments operated in store
groups owned by May and Federated.
SEASONALITY OF THE RETAIL JEWELRY BUSINESS AND FLUCTUATIONS IN OUR QUARTERLY
RESULTS COULD ADVERSELY AFFECT OUR PROFITABILITY.
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
27
quarter of 2004 accounted for 41% of our sales and 90% of our operating income.
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 our revolving credit facility. This pattern is expected to
continue. A substantial decrease in sales during the fourth quarter, whether
resulting from adverse weather conditions, natural disasters or any other cause,
would have a material adverse effect on our profitability.
OUR DEPARTMENTS ARE HEAVILY DEPENDENT ON CUSTOMER TRAFFIC AND THE CONTINUED
POPULARITY OF OUR HOST STORES AND MALLS.
The success of our departments depends, in part, on the ability of host
stores to generate consumer traffic in their stores, and the continuing
popularity of malls and department stores as shopping destinations. Sales volume
and customer traffic may be adversely affected by economic slowdowns in a
particular geographic area, the closing of anchor tenants, or competition from
retailers such as discount and mass merchandise stores and other department
stores where we do not have departments.
WE MAY NOT BE ABLE TO SUCCESSFULLY IDENTIFY, FINANCE, INTEGRATE OR MAKE
ACQUISITIONS OUTSIDE OF THE LICENSED JEWELRY DEPARTMENT BUSINESS.
We may from time to time examine opportunities to acquire or invest in
companies or businesses that complement our existing core business, such as our
recent acquisition of Carlyle. There can be no assurance that the Carlyle
acquisition or any other future acquisitions by us will be successful or improve
our operating results. In addition, our ability to complete acquisitions will
depend on the availability of both suitable target businesses and acceptable
financing. Any acquisitions may result in a potentially dilutive issuance of
additional equity securities, the incurrence of additional debt or increased
working capital requirements. Such acquisitions could involve numerous
additional risks, including difficulties in the assimilation of the operations,
products, services and personnel of any acquired company, diversion of our
management's attention from other business concerns, and expansion into new
businesses with which we may have no prior experience.
OUR PROFITABILITY DEPENDS, IN PART, UPON OUR ABILITY TO CONTINUE TO OBTAIN
SUBSTANTIAL AMOUNTS OF MERCHANDISE ON CONSIGNMENT AND TO OUR ABILITY TO CONTINUE
OUR GOLD CONSIGNMENT AGREEMENT.
In recent years, on average, approximately 50% of our merchandise has been
obtained on consignment. The willingness of vendors to enter into such
arrangements may vary substantially from time to time based on a number of
factors, including the merchandise involved, the financial resources of vendors,
interest rates, availability of financing, fluctuations in gem and gold prices,
inflation, our financial condition and a number of other economic or competitive
conditions in the jewelry business or generally. In addition, our Gold
Consignment Agreement allows us to receive consignment merchandise by providing
gold, or otherwise making payment, to certain vendors. As the price of gold
increases, the amount of consigned gold that is available to us is reduced
pursuant to the limitations of the Gold Consignment Agreement. Although we
expect to renew the Gold Consignment Agreement upon its expiration on July 31,
2005, there can be no assurances that such renewal will actually occur. If the
agreement is not renewed or replaced, our ability to receive gold merchandise on
consignment through such an arrangement and on favorable terms may be materially
adversely affected. Additionally, in the event that this agreement is
terminated, we would be required to return the gold or purchase the outstanding
gold at the prevailing, and potentially higher, gold price in effect on that
date.
28
TERRORIST ATTACKS, ACTS OF WAR, OR OTHER FACTORS AFFECTING DISCRETIONARY
CONSUMER SPENDING MAY ADVERSELY AFFECT OUR INDUSTRY, OUR OPERATIONS AND OUR
PROFITABILITY.
Terrorist activities, armed hostilities and other political instability, as
well as a decline in general economic conditions, including the country's
financial markets, a decline in consumer credit availability, or increases in
prevailing interest rates, could materially reduce discretionary consumer
spending particularly with respect to luxury items and, therefore, materially
adversely affect our business and financial condition, especially if such
changes were to occur in the fourth quarter of our fiscal year.
VOLATILITY IN THE AVAILABILITY AND COST OF PRECIOUS METALS AND PRECIOUS AND
SEMI-PRECIOUS STONES COULD ADVERSELY AFFECT OUR BUSINESS.
The jewelry industry in general is affected by fluctuations in the prices of
precious metals and precious and semi-precious stones. The availability and
prices of gold, diamonds and other precious metals and precious and
semi-precious stones may be influenced by cartels, political instability in
exporting countries and inflation. Shortages of these materials or sharp changes
in their prices could have a material adverse effect on our results of
operations or financial condition. Although we attempt to protect against such
fluctuations in the price of gold by entering into gold forward contracts, there
can be no assurance that these hedging practices will be successful or that
hedging transactions will not adversely affect our results of operations or
financial condition.
THE RETAIL JEWELRY BUSINESS IS HIGHLY COMPETITIVE.
We face competition for retail jewelry sales from national and regional
jewelry chains, other department stores, local independently owned jewelry
stores and chains, specialty stores, mass merchandisers, catalog showrooms,
discounters, direct mail suppliers, internet merchants and televised home
shopping. Some of our competitors are substantially larger and have greater
financial resources than our business.
WE MAY NOT BE ABLE TO COLLECT PROCEEDS FROM OUR HOST STORES.
Our license agreements typically require the host stores to remit the net
sales proceeds for each month to us approximately three weeks after the end of
such month. However, we cannot assure you that we will timely collect the net
sales proceeds due to us from our host stores. If one or more host stores fail
to remit the net sales proceeds for a substantial period of time or during the
fourth quarter of our fiscal year due to financial instability, insolvency or
otherwise, this could have a material adverse impact on our liquidity.
WE ARE DEPENDENT ON SEVERAL KEY VENDORS AND OTHER SUPPLIERS.
In 2004, merchandise obtained by us from our five largest vendors generated
approximately 31% of sales, and merchandise obtained from our largest vendor
generated approximately 10% of sales. Additionally, in Carlyle's most recent
fiscal year, merchandise obtained from its two largest vendors generated
approximately 20% of their sales. There can be no assurances that we can
identify, on a timely basis, alternate sources of merchandise supply in the case
of an abrupt loss of any of our significant suppliers.
OUR SUCCESS DEPENDS ON OUR ABILITY TO IDENTIFY AND RAPIDLY RESPOND TO
FASHION TRENDS.
The jewelry industry is subject to rapidly changing fashion trends and
shifting consumer demands. Accordingly, our success depends on the priority that
our target customers place on fashion and our ability to anticipate, identify
and capitalize upon emerging fashion trends.
29
WE MAY NOT BE ABLE TO SUCCESSFULLY EXPAND OUR BUSINESS OR INCREASE THE
NUMBER OF DEPARTMENTS WE OPERATE.
A significant portion of our growth in sales and income from operations in
recent years has resulted from our ability to obtain licenses to operate
departments in new host store groups and the addition of new departments in
existing host store groups. We cannot predict the number of departments we will
operate in the future or whether our expansion, if any, will be at levels
comparable to that experienced to date. In a few cases, we are subject to
limitations under our license agreements which prohibit us from operating
departments for competing host store groups within a certain geographical radius
of the host stores (typically five to ten miles) without the host store's
permission. Such limitations restrict us from further expansion within areas
where we currently operate departments, including expansion through possible
acquisitions. If we cannot obtain required consents, we will be limited in our
ability to expand further in areas near our existing host stores.
WE COULD BE MATERIALLY ADVERSELY AFFECTED IF OUR DISTRIBUTION OPERATIONS ARE
DISRUPTED.
We operate a central distribution facility and we do not have other
facilities to support our distribution needs. As a result, if this distribution
facility were to shut down or otherwise become inoperable or inaccessible for
any reason, we could incur higher costs and longer lead times associated with
the distribution of merchandise to our stores during the time it takes to reopen
or replace the facility.
WE ARE HEAVILY DEPENDENT ON OUR MANAGEMENT INFORMATION SYSTEMS.
The efficient operation of our business is heavily dependent on our
fully-integrated management information systems. In particular, we rely on our
inventory and merchandising control system, which allows us to make better
decisions in the allocation and distribution of our merchandise. Our business
and operations could be materially and adversely affected if our systems were
inoperable or inaccessible or if we were not able, for any reason, to
successfully restore our systems and fully execute our disaster recovery plan.
WE DEPEND ON KEY PERSONNEL.
Our success depends to a significant extent upon our ability to retain key
personnel, particularly Arthur E. Reiner, our Chairman and Chief Executive
Officer. The loss of Mr. Reiner's services or one or more of our current members
of senior management, or our failure to attract talented new employees, could
have a material adverse effect on our business.
OUR SUBSTANTIAL DEBT AND DEBT SERVICE REQUIREMENTS COULD ADVERSELY AFFECT
OUR BUSINESS.
We currently have a significant amount of debt. As of April 30, 2005, we had
$200.0 million of debt outstanding (not including $12.6 million in letters of
credit under our $225.0 million revolving credit facility). In 2004, our average
revolver balance was $50.6 million and we peaked in usage at $99.8 million. In
addition, as of April 30, 2005, the value of gold outstanding under the Gold
Consignment Agreement totaled $49.6 million. Subject to the terms of our
indebtedness, we may incur additional indebtedness, including secured debt, in
the future.
THE TERMS OF OUR DEBT INSTRUMENTS AND OTHER OBLIGATIONS IMPOSE FINANCIAL AND
OPERATING RESTRICTIONS.
Our Revolving Credit Agreement, Gold Consignment Agreement and the indenture
relating to the New Senior Notes contain restrictive covenants that will limit
our ability to engage in activities that may be in our long-term best interests.
These covenants include limitations on, or relating to, capital
30
expenditures, liens, indebtedness, investments, mergers, acquisitions,
affiliated transactions, management compensation and the payment of dividends
and other restricted payments.
THE FUTURE IMPACT OF LEGAL AND REGULATORY ISSUES IS UNKNOWN.
Our business is subject to government laws and regulations including, but
not limited to, employment laws and regulations, state advertising regulations,
quality standards imposed by federal law, and other laws and regulations. A
violation or change of these laws could have a material adverse effect on our
business, financial condition and results of operations. In addition, the future
impact of litigation arising in the ordinary course of business may have an
adverse effect on the financial results or reputation of the company.
Readers are cautioned not to rely on these forward-looking statements, which
reflect 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
2004, a 100 basis point change in interest rates would have resulted in an
increase in interest expense of approximately $0.5 million in 2004. 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 April 30, 2005, we
had several open positions in gold forward contracts totaling 22,050 fine troy
ounces, to purchase gold for $9.6 million. The fair value of gold under such
contracts was $9.7 million at April 30, 2005. These contracts have settlement
dates ranging from June 30, 2005 to September 30, 2005.
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer
("CEO") and Chief Financial Officer ("CFO"), carried out an evaluation of the
effectiveness of disclosure controls and procedures pursuant to 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 ensuring that material
financial and non-financial information required to be disclosed by us in
reports that we file or submit under the Exchange Act are recorded, processed,
summarized and reported within the time periods specified in the Commission's
rules and forms.
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CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
Our management, with the participation of our CEO and CFO, also conducted an
evaluation of our internal control over financial reporting, as defined in
Exchange Act Rule 13a-15(f), to determine whether any changes occurred during
the quarter ended April 30, 2005 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting. Based on that evaluation, there was no such change during the quarter
ended April 30, 2005.
A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
controls systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within Finlay Jewelry have
been detected. We conduct periodic evaluations of our controls to enhance, where
necessary, our procedures and controls. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
There have been no changes in our internal controls over financial reporting
that occurred during our last fiscal quarter to which this report relates that
have materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting.
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PART II - OTHER INFORMATION
ITEM 2. 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 first quarter of 2005.
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. As of April 30, 2005, and from inception of the
program, the Holding Company has repurchased a total of 2,207,904 shares for
$27.4 million.
ITEM 6. EXHIBITS
EXHIBIT NO. DESCRIPTION
2.1 Agreement and Plan of Merger, dated May 19, 2005, by and among
Finlay Fine Jewelry Corporation, FFJ Acquisition Corp.,
Carlyle & Co. Jewelers, certain stockholders of Carlyle & Co.
Jewelers and Russell L. Cohen (as stockholders' agent)
(incorporated by reference to Exhibit 2.1 filed as part of the
Current Report on Form 8-K filed by Finlay Jewelry on May 25,
2005).
3 Not Applicable.
4 Not Applicable.
10.1 Third Amended and Restated Credit Agreement, dated as of May
19, 2005, among Finlay Fine Jewelry Corporation and Carlyle &
Co. Jewelers, Finlay Enterprises, Inc., General Electric
Capital Corporation, individually and in its capacity as
administrative agent, Bank of America, N.A., 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 Finlay
Jewelry on May 25, 2005).
10.2 Amendment to Amended and Restated Security Agreement, dated as
of May 19, 2005, by and among Finlay Fine Jewelry Corporation,
Finlay Jewelry, Inc., Finlay Merchandising & Buying, Inc.,
eFinlay, Inc., Carlyle & Co. Jewelers, Carlyle and Co. of
Montgomery, Park Promenade, Inc. and J.E. Caldwell Co., and
General Electric Capital Corporation, individually and as
agent (incorporated by reference to Exhibit 10.2 filed as part
of the Current Report on Form 8-K filed by Finlay Jewelry on
May 25, 2005).
10.3 Consent and Amendment, dated as of May 19, 2005, among
Sovereign Bank, Sovereign Precious Metals, LLC (Sovereign Bank
and Sovereign Precious Metals, LLC individually and as
agents), Commerzbank International S.A., Finlay Fine Jewelry
Corporation and eFinlay, Inc. to the Amended and Restated Gold
Consignment Agreement, dated as of March 30, 2001, as amended
(incorporated by reference to Exhibit 10.3 filed as part of
the Current Report on Form 8-K filed by Finlay Jewelry on May
25, 2005).
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10.4 Joinder Agreement dated as of May 19, 2005 for the benefit of
General Electric Capital Corporation, as administrative agent,
in connection with (i) that certain Amended and Restated
Guaranty dated as of January 22, 2003 among the guarantors
party thereto and the agent, (ii) that certain Amended and
Restated Security Agreement dated as of January 22, 2003 among
the grantors party thereto and the agent and (iii) that
certain Amended and Restated Pledge Agreement dated as of
January 22, 2003 among the pledgors party thereto and the
agent (incorporated by reference to Exhibit
10.4 filed as part of the Current Report on Form 8-K filed by
Finlay Jewelry on May 25, 2005).
10.5 Supplemental Indenture dated as of May 19, 2005 among Carlyle
& Co. Jewelers, Finlay Fine Jewelry Corporation and HSBC Bank
USA, as Trustee, together with Subsidiary Guarantee
(incorporated by reference to Exhibit 10.5 filed as part of
the Current Report on Form 8-K filed by Finlay Jewelry on May
25, 2005).
10.6 Supplemental Indenture dated as of May 19, 2005 among J.E.
Caldwell Co., Finlay Fine Jewelry Corporation and HSBC Bank
USA, as Trustee, together with Subsidiary Guarantee
(incorporated by reference to Exhibit 10.6 filed as part of
the Current Report on Form 8-K filed by Finlay Jewelry on May
25, 2005).
10.7 Supplemental Indenture dated as of May 19, 2005 among Carlyle
& Co. of Montgomery, Finlay Fine Jewelry Corporation and HSBC
Bank USA, as Trustee, together with Subsidiary Guarantee
(incorporated by reference to Exhibit 10.7 filed as part of
the Current Report on Form 8-K filed by Finlay Jewelry on May
25, 2005).
10.8 Supplemental Indenture dated as of May 19, 2005 among Park
Promenade, Inc., Finlay Fine Jewelry Corporation and HSBC Bank
USA, as Trustee, together with Subsidiary Guarantee
(incorporated by reference to Exhibit 10.8 filed as part of
the Current Report on Form 8-K filed by Finlay Jewelry on May
25, 2005).
11 Statement re: Computation of earnings per share (not required
because the relevant computation can be clearly determined
from material contained in the financial statements).
15 Not applicable.
18 Not applicable.
19 Not applicable.
22 Not applicable.
23 Not applicable.
24 Not applicable.
31.1 Certification of principal executive officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 302.
31.2 Certification of principal financial officer pursuant to the
Sarbanes-Oxley Act of 2002, Section 302.
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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: June 3, 2005 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)
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