<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended January 31, 1998
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _______________ to _______________
Commission file number: 0-25716
FINLAY ENTERPRISES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3492802
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
529 FIFTH AVENUE, NEW YORK, NY 10017
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
212-808-2800
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section12(g) of the Act:
Common Stock, par value $0.01 per share
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [x]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing price on the Nasdaq National Market for
such shares on March 17, 1998 was $153,409,927.
As of March 12, 1998, there were 9,779,703 shares of common stock, par
value $.01 per share, of the registrant outstanding.
Documents incorporated by reference:
Portions of the Company's definitive Proxy Statement, in connection with
its Annual Meeting to be held in June 1998, are incorporated by reference into
Part III. The Company's Proxy Statement will be filed within 120 days after
January 31, 1998.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
FINLAY ENTERPRISES, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED JANUARY 31, 1998
INDEX
<TABLE>
<CAPTION>
PAGES(S)
--------
<S> <C> <C>
PART I
Item 1. Business............................................................................ 3
Item 2. Properties.......................................................................... 15
Item 3. Legal Proceedings................................................................... 16
Item 4. Submission of Matters to a Vote of Security Holders................................. 16
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters........... 16
Item 6. Selected Consolidated Financial Data................................................ 17
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................... 19
Item 8. Financial Statements and Supplementary Data......................................... 26
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure............................................... 26
PART III
Item 10. Directors and Executive Officers of the Registrant.................................. 27
Item 11. Executive Compensation.............................................................. 29
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................................................ 29
Item 13. Certain Relationships and Related Transactions...................................... 30
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K....................................................................... 31
SIGNATURES....................................................................................... 38
</TABLE>
2
<PAGE>
PART I
ITEM 1. BUSINESS
THE COMPANY
Finlay Enterprises, Inc., a Delaware corporation (the 'Company'), conducts
business through its wholly owned subsidiary, Finlay Fine Jewelry Corporation, a
Delaware corporation, and its wholly owned subsidiaries ('Finlay Jewelry').
References to 'Finlay' mean, collectively, the Company, Finlay Jewelry and all
predecessor businesses. All references herein to 'Departments' refer to fine
jewelry departments operated pursuant to license agreements or other
arrangements with host department stores.
Finlay is one of the leading retailers of fine jewelry in the United States
and France. The Company operates leased fine jewelry departments ('Departments')
in major department stores for retailers such as May Department Stores ('May'),
Federated Department Stores ('Federated'), Galeries Lafayette, Belk, Carson
Pirie Scott and Proffitt's and, with the completion of its recent acquisition of
certain assets of the Diamond Park Fine Jewelers division of Zale Corporation
('Diamond Park'), operates Departments in Mercantile Stores, Marshall Field's
and Parisian. Finlay sells a broad selection of moderately priced fine jewelry,
including necklaces, earrings, bracelets, rings and watches, and markets these
items principally as fashion accessories with an average sales price of
approximately $157 per item. Average sales per Department were $749,000 in 1997
and the average size of a Department is approximately 1,000 square feet.
Finlay's sales have increased from $505.6 million in 1993 to $769.9 million
in 1997, a compound annual growth rate of 11.1%. Income from operations has
increased from $33.8 million to $61.8 million in the same period, a compound
annual growth rate of 16.3%. Finlay has increased in size from 746 Departments
at the beginning of 1993 to 1,105 Departments and 12 stand-alone stores, for a
total of 1,117 locations at the end of 1997.
As of January 31, 1998, Finlay operated its 1,117 locations in 31 host
store groups, located in 45 states, the District of Columbia, France, the United
Kingdom and Germany. By acquiring the Diamond Park assets on October 6, 1997,
Finlay added 139 Departments in three host store groups, located in 19 states.
Finlay's largest host store relationship is with May, for which Finlay has
operated Departments since 1948. Finlay operates the fine jewelry departments in
all of May's 367 department stores, including Lord & Taylor and Filene's.
Finlay's second largest host store relationship is with Federated, for which
Finlay has operated Departments since 1983. Finlay operates Departments in 156
of Federated's 401 department stores, including Rich's and Burdines. Over the
past three years, store groups owned by May and Federated accounted for an
average of 46% and 22%, respectively, of Finlay's annual sales. Management
believes that it maintains excellent relations with its host store groups, 21 of
which have had leases with Finlay for more than five years (representing 79.7%
of Finlay's sales in 1997) and 15 of which have had leases with Finlay for more
than ten years (representing 70.2% of Finlay's sales in 1997).
Finlay entered the international fine jewelry retailing market in October
1994 by acquiring Societe Nouvelle d' Achat de Bijouterie--S.O.N.A.B. ('Sonab'),
the largest operator of Departments in France, operating 147 Departments in five
host store groups, including Galeries Lafayette, Nouvelles Galeries and Bazar de
L'Hotel de Ville. During October 1996, Finlay expanded into Berlin, Germany with
the opening of a Department in a new Galeries Lafayette store.
As of January 31, 1998, Finlay also operated nine domestic stand alone
discount jewelry outlet stores at nonmetropolitan outlet shopping center
locations in Ohio, New York, Florida, South Carolina, Pennsylvania, Georgia and
California under the name 'New York Jewelry Outlet'. The outlet stores provide
Finlay with a channel to sell discontinued, close-out and certain other
merchandise.
Finlay's fiscal year ends on the Saturday closest to January 31. References
to 1993, 1994, 1995, 1996, 1997 and 1998 relate to the fiscal years ending on
January 29, 1994, January 28, 1995, February 3, 1996, February 1, 1997, January
31, 1998 and January 30, 1999, respectively. Each of the fiscal years includes
52 weeks except 1995, which included 53 weeks.
3
<PAGE>
The Company is a holding company and has no operations of its own. The
primary asset of the Company is the common stock of Finlay Jewelry, which
conducts all of Finlay's operations. The principal executive offices of the
Company are located at 529 Fifth Avenue, New York, New York 10017 and its
telephone number at this address is (212) 808-2800.
On September 11, 1997, Finlay amended its $135.0 million revolving credit
facility by (i) increasing the line of credit to $175.0 million, (ii) including
eligible international assets in the borrowing base formula, (iii) reducing
interest rates, (iv) permitting higher balances during the annual balance
reduction period and (v) extending the maturity date from May 1998 to March 2003
(the 'Revolving Credit Facility'). Upon completion of the acquisition of Diamond
Park (the 'Diamond Park Acquisition'), the line of credit was further increased
to $225.0 million.
On October 6, 1997, Finlay completed the acquisition of Diamond Park, a
leading operator of Departments, for approximately $63.0 million. By acquiring
Diamond Park, Finlay added 139 Departments that had total sales of $103.0
million for the twelve months ended January 31, 1998 and also added new host
store relationships with Mercantile Stores, Marshall Field's and Parisian.
Management believes that, in addition to increasing sales volume, the Diamond
Park Acquisition will improve Finlay's results of operations through the
leveraging of expenses and the achievement of other operating synergies.
On October 21, 1997, the Company completed a public offering (the '1997
Offering') of 3,450,000 shares of its Common Stock at a price of $19.00 per
share, of which 2,196,971 shares were issued and sold by the Company. An
additional 1,253,029 shares were sold by existing stockholders. The
underwriters' over-allotment was exercised in full. Net proceeds to the Company
from the 1997 Offering were $38,100,000. The Company expects to use the funds
resulting from the 1997 Offering for working capital, repayment of indebtedness
or other general corporate purposes.
On March 24, 1998, the Company filed a registration statement with the
Securities and Exchange Commission (the 'Commission') for a proposed public
offering of 1,600,000 shares of its common stock, par value $.01 per share
('Common Stock') (the 'Equity Offering'), of which 567,310 shares are expected
to be issued and sold by the Company and 1,032,690 shares are expected to be
sold by certain selling stockholders. Concurrently with the filing of the
registration statement relating to the Equity Offering, the Company and Finlay
Jewelry filed registration statements with the Commission for the proposed
public offering of $75.0 million aggregate principal amount of Senior Debentures
due 2008 (the 'Senior Debentures') and $150.0 million aggregate principal amount
of Senior Notes due 2008 (the 'Senior Notes'), respectively. In addition, it is
contemplated that, concurrently with the consummation of the sale of the Senior
Debentures and Senior Notes, the existing revolving credit agreement (the
'Revolving Credit Agreement') among the Company, Finlay Jewelry, certain lenders
named therein and General Electric Capital Corporation, as agent, setting forth
the terms of the Revolving Credit Facility will be amended to increase the line
of credit thereunder to $275.0 million and to make certain other changes. It is
contemplated that the net proceeds to the Company from the Equity Offering, the
sale of the Senior Debentures, the repayment of a note receivable of
approximately $1.3 million (including accrued interest thereon) from an
executive officer and the repayment of approximately $2.6 million of an
intercompany liability by Finlay Jewelry (the 'Intercompany Repayment') will be
used to redeem the Company's existing 12% Senior Discount Debentures due 2005
(the 'Debentures'), including associated premiums. It is also contemplated that
Finlay Jewelry will use the net proceeds from the sale of the Senior Notes,
together with available cash of approximately $1.0 million, to redeem Finlay
Jewelry's existing 10 5/8% Senior Notes due 2003 (the 'Notes'), including
associated premiums, and to make the Intercompany Repayment. The above
referenced transactions, excluding the Equity Offering, are referred to herein
as the 'Refinancing'. It is anticipated that the sale of the Senior Debentures,
the sale of the Senior Notes and the proposed amendment to the Revolving Credit
Agreement will be conditioned upon each other and that the Refinancing and the
Equity Offering will not be conditioned upon each other. There can be no
assurance that the Equity Offering or the Refinancing will be consummated.
On May 1, 1998, the Company intends to repurchase, subject to satisfaction
of certain covenants and conditions, the original issue discount on the
Debentures in an amount of approximately $39.0 million. The Company intends to
effect such repurchase whether or not the Refinancing or the Equity Offering is
consummated.
On April 6, 1995, the Company completed an initial public offering (the
'Initial Public Offering') of 2,500,000 shares of its Common Stock, at a price
of $14.00 per share. An additional 115,000 shares were sold by non-management
selling stockholders. Net proceeds from the Initial Public Offering were
4
<PAGE>
$30,200,000 and were used to repurchase $6,103,000 accreted balance of the
Debentures, with the balance of the net proceeds used to reduce a portion of the
outstanding indebtedness incurred under the Revolving Credit Agreement.
Immediately prior to completion of the Initial Public Offering, the holders
of the Company's 10% Series C Cumulative Preferred Stock ('Series C Preferred
Stock') exchanged all outstanding shares of Series C Preferred Stock with the
Company for 2,581,784 shares of Common Stock (the 'Series C Exchange'). For
purposes of the Series C Exchange, the outstanding Series C Preferred Stock was
(i) valued at its liquidation value of $30,000,000 plus $6,145,000 of accrued
dividends through the date of completion of the Series C Exchange, paid in kind
at a quarterly rate of 2.5%, and (ii) exchanged for Common Stock at the initial
public offering price of $14.00 per share.
In May 1993, an affiliate of Thomas H. Lee Company (together with its
affiliate transferees, the 'Lee Investors') and partnerships managed by Desai
Capital Management Incorporated (collectively, the 'Desai Investors') acquired
36.8% and 24.5%, respectively, of the then outstanding voting securities of the
Company in a series of transactions which recapitalized the Company (the '1993
Recapitalization'). Following the 1993 Recapitalization, certain members of
management (the 'Management Stockholders') maintained a substantial equity
interest in the Company. Following the completion of the Initial Public Offering
and the Series C Exchange in April 1995, the Lee Investors and Desai Investors
beneficially owned 33.1% and 22.1% of the outstanding voting securities,
respectively, and 14.8% was held by the Management Stockholders. For information
regarding the 1993 Recapitalization, reference is made to the information to be
included under the caption 'Certain Relationships and Related Transactions--The
1993 Recapitalization' in the Company's definitive Proxy Statement to be filed
pursuant to Regulation 14A ('Proxy Statement'), which information is
incorporated herein by reference. See also Note 1 to the Consolidated Financial
Statements of the Company and 'Security Ownership of Certain Beneficial Owners
and Management'.
GENERAL
OVERVIEW. Host stores benefit from outsourcing the operation of their fine
jewelry departments. By engaging Finlay, host stores gain specialized
managerial, merchandising, selling, marketing, inventory control and security
expertise. Additionally, by avoiding the high working capital investment
typically required of the jewelry business, host stores improve their return on
investment and can potentially increase their profitability.
As a lessee, Finlay benefits from the host stores' reputation, customer
traffic, advertising, credit services and established customer base. Finlay also
avoids the substantial capital investment in fixed assets typical of stand-alone
retail formats, which generally has enabled Finlay's new Departments to achieve
profitability within their first twelve months of operation. Finlay further
benefits because net sales proceeds are generally remitted to Finlay by each
host store on a monthly basis with essentially all customer credit risk borne by
the host store.
As a result of Finlay's strong relationships with its vendors, management
believes that the Company's working capital requirements are lower than those of
many other jewelry retailers. In recent years, on average, approximately 50% of
Finlay's domestic merchandise has been carried on consignment. The use of
consignment merchandise also reduces Finlay's inventory exposure to changing
fashion trends because unsold consigned merchandise can be returned to the
vendor.
INDUSTRY. Management believes that current trends in jewelry retailing,
particularly in the department store sector, provide a significant opportunity
for Finlay's growth. Consumers spent approximately $42 billion on jewelry
(including both fine and costume jewelry) in the United States in 1997, an
increase of approximately $16 billion over 1987, according to the United States
Department of Commerce. In the department store sector in which Finlay operates,
consumers spent $4 billion on fine jewelry in 1996. Management believes that
demographic factors such as the maturing of the U.S. population and an increase
in the number of working women have resulted in greater disposable income, thus
contributing to the growth of the fine jewelry retailing industry. Management
also believes that jewelry consumers today increasingly perceive fine jewelry as
a fashion accessory, resulting in purchases which augment the Company's gift and
special occasion sales. Finlay's Departments are
5
<PAGE>
typically located in 'high traffic' areas of leading department stores, enabling
Finlay to capitalize on these consumer buying patterns.
GROWTH STRATEGY. Finlay intends to pursue the following key initiatives to
increase sales and earnings:
o INCREASE COMPARABLE DEPARTMENT SALES. In 1996 and 1997, Finlay
achieved comparable Department sales increases of 5.9% and 5.5%,
respectively, outpacing the majority of its host stores. These
increases were achieved primarily by emphasizing key merchandise
items, increasing focus on holiday and event-driven promotions,
participating in host store marketing programs and positioning its
Departments as a 'destination location' for fine jewelry. Finlay
believes that comparable Department sales will continue to benefit
from these merchandising and marketing strategies, as well as from
increasing demand for fine jewelry.
o ADD DEPARTMENTS WITHIN EXISTING HOST STORE GROUPS. Finlay's well
established relationships with many of its host store groups have
enabled the Company to add Departments in new locations opened by
existing host stores. Finlay has operated Departments in May stores
since 1948 and operates the fine jewelry departments in all of May's
367 department stores. Finlay also has operated Departments in
Federated stores since 1983 and operates Departments in 156 of
Federated's 401 department stores. Since the beginning of 1993, host
store expansion has added 123 net new Departments, including 63 net
new Departments since the beginning of 1995. Based on expansion
plans announced by May Department Stores in May 1997, Finlay
believes it will have the opportunity to open approximately 100 new
Departments in May stores alone over the next five years (excluding
possible closings).
o ESTABLISH NEW HOST STORE RELATIONSHIPS. Finlay has an opportunity
to grow by establishing new relationships with department stores
that presently either lease their fine jewelry departments to
Finlay's competitors or operate their own fine jewelry departments.
Finlay seeks to establish these new relationships by demonstrating
to department store management the potential for improved financial
performance. Since the beginning of 1992, Finlay has added such host
store groups as Burdines, The Bon Marche, Elder Beerman and Stern's.
Over the past three years, Finlay has added 27 Departments in the
Hecht's division of May as a result of May's acquisition of John
Wanamaker and Strawbridge's. By acquiring Diamond Park, Finlay added
Mercantile Stores, Marshall Field's and Parisian to its host store
relationships.
o EXPAND INTERNATIONAL OPERATIONS. In October 1994, Finlay acquired
Sonab, the largest operator of Departments in France. In 1996 and
1997, Finlay expanded in France by adding 26 and 16 Departments in
Monoprix, respectively, and plans to open an additional 16 Monoprix
Departments in 1998. Finlay now operates 147 Departments in France
through five host store groups, including Galeries Lafayette,
Nouvelles Galeries and Bazar de L'Hotel de Ville. Based on mutual
agreement, Finlay closed its Debenhams operations in 1998. Finlay
expects to open new Departments in other host stores in England in
1998. In 1996, the Company also opened a Department in a new
Galeries Lafayette store in Berlin, Germany and is exploring
additional opportunities in other European countries.
o CONTINUE TO IMPROVE OPERATING LEVERAGE. Selling, general and
administrative expenses as a percentage of sales declined from 44.2%
in 1993 to 42.2% in 1997. Finlay seeks to continue to leverage
expenses both by increasing sales at a faster rate than expenses and
by reducing its current level of certain operating expenses. For
example, Finlay has demonstrated that by increasing the selling
space (with host store approval) of certain high volume Departments,
incremental sales can be achieved without having to incur
proportionate increases in selling and administrative expenses. In
addition, management believes the Company will benefit from recent
investments in technology and refinements of operating procedures
designed to allow Finlay's sales associates more time for customer
sales and service. Finlay's new distribution and warehouse facility,
expected to become fully operational in the Spring of 1998, will
permit the Company to improve the flow of merchandise to Departments
while reducing payroll and freight costs.
6
<PAGE>
Additionally, since 1994 the Company has opened nine domestic stand-alone
discount jewelry outlet stores which provide Finlay with a channel to sell
discontinued, close-out and certain other merchandise.
MERCHANDISING STRATEGY. Finlay seeks to maximize sales and profitability
through a unique merchandising strategy known as the 'Finlay Triangle', which
integrates store management (including host store management and Finlay's store
group management), vendors and Finlay's central office. By coordinating efforts
and sharing access to information, each Finlay Triangle participant plays a role
which emphasizes its area of expertise in the merchandising process, thereby
increasing productivity. Finlay's central office functions as a service
organization, assembling an assortment of merchandise for selection by Finlay's
store group management. Within pricing guidelines set by the central office,
Finlay's store group management contributes to the selection of the specific
merchandise most appropriate to the demographics and customer tastes within
their particular geographical area. Finlay's advertising initiatives and
promotional planning are closely coordinated with both host store management and
Finlay's store group management to ensure the effective use of Finlay's
marketing programs. Vendors participate in the decision-making process with
respect to merchandise assortment, including the testing of new products,
marketing, advertising, stock levels and pricing strategy. By utilizing the
Finlay Triangle, opportunities are created for the vendor to assist in
identifying fashion trends, thereby improving inventory turnover and
profitability, both for the vendor and Finlay. As a result, management believes
it capitalizes on economies of scale by centralizing certain activities, such as
vendor selection, advertising and planning, while allowing store management the
flexibility to implement merchandising programs tailored to the host store
environments and clientele.
THE FINLAY TRIANGLE
----------------------
/| CENTRAL | _
/ | OFFICE ||\
/ _---------------------- \
/ /| \ \
/ / \ \
/ / \ \
/ / \ \
/ / \ \
|/_ / _\| \
---------------------- / ----------------------
| | ---------- | STORE |
| VENDORS | \ \ | MANAGEMENT |
---------------------- ---------- ----------------------
/
Finlay has structured its relationships with vendors to encourage sharing
of responsibility for marketing and merchandise management. Finlay furnishes to
vendors, through on-line access to Finlay's information systems, the same sales,
stock and gross margin information that is available to Finlay's store group
management and central office for each of the vendor's styles in Finlay's
merchandise assortment. Using this information, vendors are able to participate
in decisions to replenish inventory which has been sold and to return or
exchange slower-moving merchandise. In addition, vendors may input order
recommendations through Finlay's data processing system for approval by Finlay.
New items are tested in specially selected 'predictor' Departments where sales
experience can indicate an item's future performance in Finlay's other
Departments. Management believes that the access and input which vendors have in
the merchandising process results in a better assortment, timely replenishment,
higher turnover and higher sales of inventory, differentiating Finlay from its
competitors.
Since many of the host store groups in which Finlay operates differ in
fashion image and customer demographics, Finlay's flexible approach to
merchandising is designed to complement each host
7
<PAGE>
store's own merchandising philosophy. Finlay emphasizes a 'fashion accessory'
approach to fine jewelry and watches, and seeks to provide items that coordinate
with the host store's fashion focus as well as to maintain stocks of traditional
and gift merchandise.
STORE RELATIONSHIPS
HOST STORE RELATIONSHIPS. As of January 31, 1998, Finlay operated 1,117
locations (including 12 stand-alone stores) in 31 host store groups, located in
45 states, the District of Columbia, France, the United Kingdom and Germany. By
acquiring Diamond Park, Finlay added 139 Departments in three host store groups,
located in 19 states. Finlay's largest host store relationship is with May, for
which Finlay has operated Departments since 1948. Finlay operates the fine
jewelry departments in all of May's 367 department stores, including Lord &
Taylor and Filene's. Finlay's second largest host store relationship is with
Federated, for which Finlay has operated Departments since 1983. Finlay operates
Departments in 156 of Federated's 401 department stores, including Rich's and
Burdines. Over the past three years, store groups owned by May and Federated
accounted for an average of 46% and 22%, respectively, of Finlay's annual sales.
Finlay also operates Departments in numerous other host store groups, such
as Galeries Lafayette, Belk, Carson Pirie Scott and Proffitt's. Management
believes that it maintains excellent relations with its host store groups, 21 of
which have had leases with Finlay for more than five years (representing 79.7%
of Finlay's sales in 1997) and 15 of which have had leases with Finlay for more
than ten years (representing 70.2% of Finlay's sales in 1997). As a consequence
of the strong and, in many instances, long-term relationships, host store groups
have routinely renewed Finlay's lease agreements at their renewal dates.
Management believes that the majority of its lease agreements will continue to
be renewed routinely.
8
<PAGE>
The following table identifies the host store groups in which Finlay
operated Departments at January 31, 1998, the year in which Finlay's
relationship with each host store group commenced and the number of Departments
operated by Finlay in each host store group. The table also provides similar
information regarding Finlay's international Departments, its domestic and
international stand-alone locations and the Departments added as a result of the
Diamond Park Acquisition.
<TABLE>
<CAPTION>
INCEPTION OF NUMBER OF
HOST STORE GROUP/LOCATION RELATIONSHIP DEPARTMENTS/STORES
- -------------------------------------------------------------------- ------------- ------------------
<S> <C> <C> <C>
MAY
Robinsons--May...................................................... 1948 55
Filene's............................................................ 1977 38
Lord & Taylor....................................................... 1978 63
L.S. Ayres/Famous Barr.............................................. 1979 30
Kaufmann's.......................................................... 1979 47
Foley's............................................................. 1986 55
Hecht's/Strawbridge's............................................... 1986 71
Meier & Frank....................................................... 1988 8
--
Total May Departments............................................. 367
FEDERATED
Rich's/Lazarus/Goldsmith's.......................................... 1983 72
Burdines............................................................ 1992 44
The Bon Marche...................................................... 1993 19
Stern's............................................................. 1994 21
--
Total Federated Departments....................................... 156
OTHER DOMESTIC DEPARTMENTS
Crowley's/Steinbach................................................. 1968 21
Gottschalks......................................................... 1969 32
Younkers............................................................ 1973 33
Belk................................................................ 1975 51
Carson Pirie Scott/Bergner's/Boston Store........................... 1977 50
Liberty House (1)................................................... 1983 12
The Bon-Ton......................................................... 1986 39
Dillard's (2)....................................................... 1988 5
Proffitt's.......................................................... 1991 9
Elder Beerman....................................................... 1992 34
Mercantile Stores................................................... 1997 91
Marshall Field's.................................................... 1997 21
Parisian............................................................ 1997 29
--
Total Other Domestic Departments.................................. 427
-----
Total Domestic Departments........................................ 950
INTERNATIONAL DEPARTMENTS (SONAB)
Bazar de L'Hotel de Ville........................................... 1994 6
Galeries Lafayette.................................................. 1994 30
Monoprix/Inno/Baze.................................................. 1994 52
Nouvelles Galeries.................................................. 1994 59
Debenhams (2)....................................................... 1996 7
Jeanteur............................................................ 1996 1
--
Total International Departments................................... 155
STAND-ALONE STORES
New York Jewelry Outlet............................................. 1994 9
New Gold (Sonab).................................................... 1994 3
--
Total Stand-Alone Stores.......................................... 12
-----
Total Departments and Stand-Alone Stores........................ 1,117
-----
-----
</TABLE>
- ------------------
(1) On March 19, 1998, Liberty House filed a voluntary petition in bankruptcy
under Title 11 of the United States Code (the "Bankruptcy Code").
Finlay is currently receiving weekly payments towards the outstanding
balance of $2.0 million that was due to Finlay prior to the filing of
the bankruptcy petition. Finlay believes that the bankruptcy of Liberty
House will not have a material adverse effect on Finlay's financial
position or results of its operations.
(2) The Company closed these Departments during the first quarter of 1998.
9
<PAGE>
TERMS OF LEASE AGREEMENTS. Finlay's lease agreements typically have an
initial term of one to five years. Finlay has, where possible, entered into
five-year lease agreements and expects to continue this policy. Finlay's lease
agreements generally contain renewal options or provisions for automatic renewal
absent prior notice of termination by either party. Lease renewals are for one
to five year periods. On June 18, 1997, the Company announced the extension of
its lease agreements with Federated for an additional three years. The lease
extensions apply to all of Finlay's Departments within Federated stores,
including leases for Departments in Burdines, Rich's, Lazarus, Goldsmith's and
The Bon Marche, which have been extended through February 3, 2001, and the lease
for Departments in Stern's, which has been extended through February 1, 2003. In
exchange for the right to operate a Department within the host store, Finlay
pays each host store group a lease fee, calculated as a percentage of sales
(subject to a minimum annual fee in a limited number of cases).
Finlay's domestic lease agreements generally require host stores to remit
sales proceeds for each month (without regard to whether such sales were cash,
store credit or national credit card) to Finlay approximately three weeks after
the end of such month. During the months of November and December, however, most
domestic host store groups remit to Finlay 75% of the estimated months' sales
prior to or shortly following the end of that month. Finlay's international
lease agreements generally require host stores to remit sales proceeds for each
two-week period (without regard to whether such sales were cash, store credit
card or national credit card) to Finlay approximately two weeks after the end of
such period. Each host store group withholds from the remittance of sales
proceeds a lease fee and other expenditures, such as advertising costs, which
the host store group may have made on Finlay's behalf.
Finlay is usually responsible for providing and maintaining any fixtures
and other equipment necessary to operate its Departments, while the host store
is typically required to provide clean space for installation of any necessary
fixtures. The host store is generally responsible for paying utility costs
(except certain telephone charges), maintenance and certain other expenses
associated with the operation of the Departments. All of the lease agreements
provide that Finlay is responsible for the hiring (subject to the suitability of
such employees to the host store) and discharge of its sales and Department
supervisory personnel, and substantially all domestic lease agreements require
Finlay to provide its employees with salaries and certain benefits comparable to
those received by the host store's employees. Many of Finlay's lease agreements
provide that Finlay may operate the Departments in any new stores opened by the
host store group. In certain instances, Finlay is operating Departments without
written agreements, although the arrangements in respect of such Departments are
generally in accordance with the terms described herein.
In many cases, Finlay is subject to limitations under its lease agreements
which prohibit Finlay from operating Departments for competing host store groups
within a certain geographical radius of the host stores (typically five to ten
miles). Such limitations restrict Finlay from further expansion within areas
where it currently operates Departments, including expansion by possible
acquisitions. For example, Finlay sought and received the consent of certain of
its existing host store groups in connection with the Diamond Park Acquisition.
Certain domestic lease agreements, however, make an exception for adding
Departments in stores established by groups with which Finlay has a preexisting
lease arrangement. In addition, Finlay has from time to time obtained the
consent of an existing host store group to operate in another host store group
within the prohibited area. May and Federated have granted consents of this type
to Finlay with respect to one another's stores. In addition, in certain cases,
Finlay has found that, notwithstanding the absence of any geographical
limitation in a lease agreement, it may be limited as a practical matter from
opening Departments for competing host store groups in close proximity to each
other because of the adverse effect such openings might have on its overall host
store group relationships.
CREDIT. Substantially all consumer credit risk is borne by the host store
rather than by Finlay. Purchasers of Finlay's merchandise at a host store are
entitled to the use of the host store's credit facilities on the same basis as
all of the host store's customers. Payment of credit card or check transactions
is generally guaranteed to Finlay by the host store, provided that the proper
credit approvals have been obtained in accordance with the host store's policy.
Accordingly, payment to
10
<PAGE>
Finlay in respect of its sales proceeds is generally not dependent on when (or
if) payment is received by the host store.
DEPARTMENTS OPENED/CLOSED. During 1997, Department openings offset by
closings resulted in a net increase of 178 Departments. Department openings
included 139 Departments as a result of the Diamond Park Acquisition and 16
Departments in Monoprix stores in France. In addition, there were 33 openings
within existing store groups. These openings were offset by ten Departments
closed within existing host store groups. See 'Management's Discussion and
Analysis of Financial Condition and Results of Operations--1997 Compared with
1996'.
The following table sets forth data regarding the number of Departments and
stand-alone stores which Finlay has operated from the beginning of 1993:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
------------------------------------------------------
JAN. 29, JAN. 28, FEB. 3, FEB. 1, JAN. 31,
1994 1995 1996 1997 1998
-------- -------- ------- ------- --------
<S> <C> <C> <C> <C> <C>
DEPARTMENTS/STORES:
Open at beginning of period........................... 746 757 903 941 939
Opened during period.................................. 69 159 70 84 188
Closed during period.................................. (58) (13) (32) (86) (10)
-------- -------- ------- ------- --------
Open at end of period................................. 757 903 941 939 1,117
-------- -------- ------- ------- --------
Net increase (decrease)............................... 11 146 38 (2) 178
-------- -------- ------- ------- --------
-------- -------- ------- ------- --------
</TABLE>
For the periods presented in the table above, Department closings were
primarily attributable to: the bankruptcy of, or ownership changes in, certain
host store groups, in particular internal consolidation within May; the closing
or sale by host store groups of individual stores; the closing of Departments in
a host store group as a result of the opening of Departments in another host
store group that competes in the same geographic market; host store group
decisions to consolidate with one lessee; and Finlay's decision to close
unprofitable Departments. To management's knowledge, none of the Department
closings during the periods presented in the table above resulted from
dissatisfaction of a host store group with Finlay's performance.
PRODUCTS AND PRICING
Each of Finlay's domestic Departments offers a broad selection of
necklaces, earrings, bracelets, rings and watches. Other than watches,
substantially all of the fine jewelry items sold by Finlay are made from
precious metals and many also contain diamonds or colored gemstones. Finlay also
provides jewelry and watch repair services. Finlay does not carry costume or
gold-filled jewelry. Specific brand identification is generally not important
within the fine jewelry business, except for watches. With respect to watches,
Finlay emphasizes brand name vendors, including Gucci, Seiko, Citizen and
Movado. Many of Finlay's lease agreements with host store groups restrict Finlay
from selling certain brand name items or, in some cases, set price minimums
below which Finlay may not sell particular items. Sonab's watch selection is
limited to private label watches marketed under Sonab's 'New Gold' and 'Gold
Line' names. In France, all other watch brands are sold by the host stores,
which have historically retained their watch businesses.
11
<PAGE>
The following table sets forth the domestic sales and percentage of sales
by category of merchandise for 1993, 1994, 1995, 1996 and 1997:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------------------------------------------------------------------------
JAN. 29, 1994 JAN. 28, 1995 FEB. 3, 1996 FEB. 1, 1997 JAN. 31, 1998
--------------- --------------- --------------- --------------- ---------------
% OF % OF % OF % OF % OF
CATEGORY: SALES SALES SALES SALES SALES SALES SALES SALES SALES SALES
- ---------------------- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Gemstones............. $119.0 23.6% $132.3 24.5% $148.6 24.4% $153.1 24.1% $169.0 23.4%
Gold.................. 113.3 22.4 123.7 22.9 142.8 23.5 144.8 22.8 155.1 21.6
Watches............... 96.0 19.0 105.1 19.5 115.2 19.0 114.3 18.0 126.3 17.6
Diamonds.............. 101.3 20.0 102.7 19.1 118.3 19.5 129.2 20.3 147.7 20.5
Other(1).............. 76.0 15.0 75.5 14.0 82.8 13.6 93.5 14.8 121.5 16.9
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total Sales........... $505.6 100.0% $539.3 100.0% $607.7 100.0% $634.9 100.0% $719.6 100.0%
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
</TABLE>
- ------------------
(1) Includes special promotional items, remounts, estate jewelry, pearls, beads,
cubic zirconia, sterling silver and men's jewelry, as well as repair
services and accommodation sales to Finlay employees.
See 'Management's Discussion and Analysis of Financial Condition and
Results of Operations'.
Finlay sells its merchandise at prices generally ranging from $50 to
$1,000. In 1997, the average price of the items sold by Finlay was approximately
$157 per item. An average Department has over 4,000 items in stock. Consistent
with fine jewelry retailing in general, a substantial portion of Finlay's sales
are made at prices discounted from listed retail prices. Finlay's advertising
and promotional planning are closely coordinated with its pricing strategy.
Publicized sales events are an important part of Finlay's marketing efforts. A
substantial portion of Finlay's sales occur during such promotional events. The
amount of time during which merchandise may be offered at discount prices is
limited by applicable laws and regulations. See 'Legal Proceedings'.
PURCHASING AND INVENTORY
GENERAL. A key element of Finlay's strategy has been to lower the working
capital investment required for operating its existing Departments and opening
new Departments. At any one time, Finlay typically is required to pay in advance
of sale for less than half of its inventory because in recent years, on average,
approximately 50% of Finlay's domestic merchandise has been obtained on
consignment and certain additional inventory has been purchased with extended
payment terms. In 1997, Finlay's net monthly investment in inventory (i.e., the
total cost of inventory owned and paid for) averaged 37% of the total cost of
its on-hand merchandise. Finlay is frequently granted exchange privileges which
permit Finlay to return or exchange unsold merchandise for new products at any
time. In addition, Finlay structures its relationships with vendors to encourage
their participation in and responsibility for merchandise management. By making
the vendor a participant in Finlay's merchandising strategy, Finlay has created
opportunities for the vendor to assist in identifying fashion trends, thereby
improving inventory turnover and profitability. As a result, Finlay's direct
capital investment in inventory has been reduced to levels which it believes are
low for the retail jewelry industry. In addition, Finlay's inventory exposure to
changing fashion trends is reduced because unsold consignment merchandise can be
returned to the vendor.
Management believes the willingness of vendors to participate in the
inventory management process is due, in part, to the large volume of merchandise
which Finlay sells in its Departments and the desire of vendors to take
advantage of Finlay's nationwide distribution network. By offering their
merchandise through Finlay's Departments, vendors are able to reach a broad
spectrum of the marketplace in coordination with national or regional
advertising campaigns conducted by the vendors or their service organizations.
In 1997, merchandise obtained by Finlay from its 40 largest vendors (out of
a total of approximately 400 vendors) generated approximately 78% of domestic
sales, and merchandise obtained from Finlay's largest vendor generated
approximately 12% of domestic sales. Finlay does not believe the loss of any one
of its vendors would have a material adverse effect on its business.
12
<PAGE>
In addition, Finlay's new distribution and warehouse facility, expected to
become fully operational in the Spring of 1998, will permit Finlay to improve
the flow of merchandise to Departments while reducing payroll and freight costs.
GOLD CONSIGNMENT AGREEMENT. Finlay Jewelry is party to a gold consignment
agreement (the 'Gold Consignment Agreement'), which enables Finlay to receive
merchandise by providing gold or otherwise making payment to certain vendors who
currently supply Finlay with merchandise on consignment. While the merchandise
involved remains consigned, title to the gold content of the merchandise
transfers from the vendors to the gold consignor. As a result, such vendors have
reduced their working capital requirements and associated financing costs.
Consequently, Finlay has negotiated more favorable prices and terms with the
participating vendors. Finlay can obtain, pursuant to the Gold Consignment
Agreement, up to the lesser of (i) 85,000 fine troy ounces or (ii) $25.0 million
worth of gold, subject to a formula as prescribed by the Gold Consignment
Agreement. At January 31, 1998, amounts outstanding under the Gold Consignment
Agreement totaled 39,676 fine troy ounces, valued at approximately $12.1
million. The average amount outstanding under the Gold Consignment Agreement was
$14.3 million in 1997. Finlay Jewelry is in discussions with the consignor
under such agreement to (i) renew the Gold Consignment Agreement through
December 31, 2001, (ii) allow Finlay Jewelry to obtain up to the lesser of (x)
85,000 fine troy ounces or (y) $32.0 million worth of gold and (iii) make
certain other modifications. There can, however, be no assurance that the Gold
Consignment Agreement will be amended as presently contemplated or at all.
Under the Gold Consignment Agreement, Finlay is required to pay a daily
consignment fee on the dollar equivalent of the fine gold value of the ounces of
gold consigned thereunder. The daily consignment fee is based on a floating rate
which, as of January 31, 1998, was approximately 4.3% per annum. In addition,
Finlay is required to pay an unused line fee of 0.5% if the amount of gold
consigned has a value equal to or less than $10.0 million. In conjunction with
the Gold Consignment Agreement, Finlay granted to the gold consignor a first
priority perfected lien on, and a security interest in, specified gold jewelry
of participating vendors approved under the Gold Consignment Agreement and a
lien on proceeds and products of such jewelry subject to the terms of an
intercreditor agreement between the gold consignor and the Revolving Credit
Agreement lenders.
OPERATIONS
GENERAL. Most of Finlay's Departments have between 30 and 150 linear feet
of display cases (with an average of approximately 60 linear feet) generally
located in high traffic areas on the main floor of the host stores. Each
Department is supervised by a manager whose primary duties include customer
sales and service, scheduling and training of personnel, maintaining security
controls and merchandise presentation. Most of the Departments utilize from 105
to 260 staff hours per week on a permanent basis, depending on the Department's
sales volume, and employ additional sales staff during the peak year-end holiday
season. Each Department is open for business during the same hours as its host
store. Subject to the terms of the applicable host store group lease agreement,
Finlay is generally responsible for its own operating decisions within each of
its Department operations, including the hiring and compensation of sales staff.
See '--Store Relationships--Terms of Lease Agreements'.
To parallel host store operations, Finlay establishes separate group
service organizations responsible for managing Departments operated for each
host store. Staffing for each group organization varies with the number of
Departments in each group. Typically, Finlay services each host store group with
a group manager, an assistant group manager, one or more group buyers, one or
more regional supervisors who oversee the individual Department managers and a
number of clerical employees. Each group manager reports to a regional vice
president, who is responsible for supervision of up to nine host store groups.
In its continued efforts to improve comparable Department sales through improved
operating efficiency, Finlay has taken steps to minimize administrative tasks at
the Department level by introducing advanced technology such as an interface
between store cash registers and Finlay's central office. These steps are
designed to reduce administrative time requirements, thereby improving customer
service and, as a result, sales.
Finlay had average sales per linear foot of approximately $11,800 in 1995,
$11,600 in 1996 and $11,900 in 1997. The decrease in sales per linear foot
during 1996 is attributed to more European
13
<PAGE>
Departments, which, on average, have lower sales per linear foot as compared to
the domestic Departments. Finlay had average sales per Department of
approximately $710,000, $729,000 and $749,000 in 1995, 1996 and 1997,
respectively. Finlay determines average sales per linear foot by dividing its
sales by the aggregate estimated measurements of the outer perimeters of the
display cases of Finlay's Departments.
MANAGEMENT INFORMATION AND INVENTORY CONTROL SYSTEMS. Management believes
that its management information systems provide a significant advantage in
competing with other fine jewelry retailers. Finlay and its vendors use this
system to monitor sales, gross margin and inventory performance by location,
merchandise category, style number and vendor. Using this information, Finlay is
able to monitor merchandise trends and variances in performance and improve the
efficiency of its inventory management. Finlay also measures the productivity of
its sales force by maintaining current statistics for each employee such as
sales per hour, transactions per hour and transaction size. For a discussion of
certain matters regarding the Year 2000, see 'Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources'.
PERSONNEL AND TRAINING. Finlay considers its employees an important
component of its operations and devotes substantial resources to training and
improving the quality of sales and management personnel. Finlay seeks to
motivate its employees by linking a substantial percentage of their compensation
to performance standards. In most cases, individual sales personnel are
compensated on an hourly basis and paid a commission on sales. Department
managers are generally compensated on the basis of a salary plus a percentage of
their Department's sales. Group managers and regional vice presidents are
eligible to earn bonuses of up to 50% of their base salaries upon the
achievement of specified goals.
As of the end of 1997, Finlay employed approximately 7,500 persons in the
United States and approximately 550 persons in France, the United Kingdom and
Germany, approximately 90% of whom were regional and local sales and supervisory
personnel and the balance of whom were employed in administrative or executive
capacities. Of Finlay's 7,500 domestic employees, approximately 1,900 were
part-time employees, working less than 20 hours per week. Finlay's labor
requirements fluctuate because of the seasonal nature of Finlay's business. See
'--Seasonality'. Management believes that its relations with its employees are
good. Less than 1% of Finlay's domestic employees are unionized. Substantially
all of Finlay's employees in France are, however, unionized. The average length
of service for Finlay's domestic employees at the group manager level and above
is approximately twelve years.
ADVERTISING. Finlay promotes its products through four-color direct mail
catalogs and newspaper advertising of the host store groups. Finlay maintains an
in-house advertising staff responsible for preparing a majority of Finlay's
advertisements and for coordinating the finished advertisements with the
promotional activities of the host stores. Finlay's gross advertising
expenditures over the past five fiscal years have consistently been in excess of
6% of sales, a level which is consistent with the jewelry industry's reliance on
promotional efforts to generate sales. The majority of Finlay's domestic lease
agreements with host store groups require Finlay to expend certain specified
minimum percentages of the respective Department's annual sales on advertising
and promotional activities.
INVENTORY LOSS PREVENTION AND INSURANCE. Finlay undertakes substantial
efforts to safeguard its merchandise from loss or theft, including the
installation of security alarm systems and safes at each location and the taking
of a daily diamond inventory. During 1997, inventory shrinkage amounted to
approximately 0.8% of sales. Finlay maintains insurance covering the risk of
loss of merchandise in transit or on Finlay's premises (whether owned or on
consignment) in amounts that management believes are reasonable and adequate for
the types and amounts of merchandise carried by Finlay.
GOLD HEDGING. The cost to Finlay of gold merchandise sold on consignment
in some cases is not fixed until the sale is reported to the vendor or the gold
consignor, in the case of merchandise sold pursuant to the Gold Consignment
Agreement. In such cases, the cost of merchandise varies with the price of gold
and Finlay is exposed to the risk of fluctuations in the price of gold between
the time Finlay establishes the advertised or other retail price of a particular
item of merchandise and the date on which the sale of the item is reported to
the vendor. In order to hedge against this risk and to enable Finlay to
14
<PAGE>
determine the cost of such goods prior to their sale, Finlay must fix the price
of gold prior to the sale of such merchandise. Accordingly, Finlay at times
enters into futures contracts, such as options or forwards or a combination
thereof. The value of gold hedged under such contracts represented less than 5%
of the Company's cost of goods sold in 1997. Under such contracts, the Company
obtains the right to purchase a fixed number of troy ounces of gold at a
specified price per ounce for a specified period. Such contracts typically have
durations ranging from one to nine months and are generally priced at the spot
gold price plus an amount based on prevailing interest rates plus customary
transactions costs. When sales of such merchandise are reported to the
consignment vendors and the cost of such merchandise becomes fixed, Finlay sells
its related hedge position. Finlay did not have any open positions in futures
contracts for gold at February 1, 1997 or January 31, 1998.
The primary effect on liquidity from using futures contracts is associated
with the related margin requirements. Historically, cash flows related to
futures margin requirements have not been material to Finlay's total working
capital requirements. Finlay manages the purchase of futures contracts by
estimating and monitoring the quantity of gold that it anticipates it will
require in connection with its anticipated level of sales of the type described
above. Finlay's gold hedging transactions are entered into by Finlay in the
ordinary course of its business. Finlay's gold hedging strategies are
determined, implemented and monitored on a regular basis by Finlay's senior
management and its Board of Directors.
COMPETITION
Finlay faces competition for retail jewelry sales from national and
regional jewelry chains, other department stores, local independently owned
jewelry stores and chains, specialty stores, mass merchandisers, catalog
showrooms, discounters, direct mail suppliers and televised home shopping.
Several of Finlay's competitors are substantially larger and have greater
financial resources than Finlay. Management believes that competition in the
retail jewelry industry is based primarily on the price, quality, fashion appeal
and perceived value of the product offered and on the reputation, integrity and
service of the retailer.
With respect to the operation of Departments in host store groups, Finlay
competes with a limited number of other established Department lessees, such as
J.B. Rudolph, and department store chains. Management believes that competition
for the operation of Departments is based principally on the reputation of the
operator for integrity, the expertise and experience of the operator in offering
an attractive selection of merchandise at competitive prices, and the operator's
ability to generate lease fees for the host stores. See '--Store
Relationships--Terms of Lease Agreements' with respect to certain limitations on
Finlay's ability to compete.
SEASONALITY
The retail jewelry business is highly seasonal. See 'Selected Consolidated
Financial Data' and 'Management's Discussion and Analysis of Financial Condition
and Results of Operations-- Seasonality'.
ITEM 2. PROPERTIES
The only real estate owned by Finlay is the distribution and warehouse
facility, totaling 106,200 square feet (of which 17,350 is leased to a tenant),
at 205 Edison Avenue, Orange, Connecticut. Finlay leases approximately 18,400
square feet at 521 Fifth Avenue, New York, New York, and 49,100 square feet at
529 Fifth Avenue, New York, New York for its executive, accounting, advertising,
the majority of its data processing operations and other administrative
functions. The leases for such space expire September 30, 2008. For certain
operations at 500 Eighth Avenue, New York, New York, Finlay has leased
approximately 9,200 square feet under a lease which expires January 31, 2000.
Finlay also leases retail space for its New York Jewelry Outlet and French
stand-alone stores and office space in France for Sonab's corporate operations.
Generally, as part of Finlay's domestic lease arrangements, host stores provide
office space to Finlay's host store group management personnel free of charge.
15
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
Finlay is involved in certain legal actions arising in the ordinary course
of business. Management believes none of these actions, either individually or
in the aggregate, will have a material adverse effect on Finlay's business,
financial position or results of operations.
Commonly in the retail jewelry industry, a substantial amount of
merchandise is sold at a discount to the 'regular' or 'original' price. Finlay's
experience is consistent with this practice. See 'Business-- Products and
Pricing'. A number of states in which Finlay operates have regulations which
require retailers who offer merchandise at discounted prices to offer the
merchandise at the 'regular' or 'original' prices for stated periods of time.
Finlay has received inquiries and has been subject to investigation from time to
time by various states with respect to its compliance with such regulations. In
1987 and 1989, Finlay entered into consent decrees with the states of Wisconsin
and Georgia, respectively, in connection with Finlay's past sales discounting
and other practices and paid nominal fines to both states. In addition, one of
Finlay's store groups entered into a consent decree with the state of Oregon in
1988 and two others are subject to standing injunctions, one issued at the
request of the state of California in 1988 and the other issued at the request
of the state of Colorado in 1990, regarding the sales discounting practices of
the host store groups in the respective states. As a lessee of the host store
groups, Finlay is obligated to comply with the consent decree and injunctions in
effect with respect to the host store groups. Although Finlay receives inquiries
from various state authorities from time to time, management believes it is in
substantial compliance with all applicable federal and state laws with respect
to such practices.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Common Stock of the Company is traded on the Nasdaq National Market
under the symbol 'FNLY'. The high and low sales prices for the Common Stock
during 1996 and 1997 were as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-------------------------------------------------------
JANUARY 31,
FEBRUARY 1, 1997 1998
------------------------------------ ---------------
HIGH LOW HIGH
---------------- ---------------- ---------------
<S> <C> <C> <C>
First Quarter................................................ $15 $10 1/4 $16 1/2
Second Quarter............................................... 17 1/8 13 1/8 18
Third Quarter................................................ 15 3/8 12 21 7/8
Fourth Quarter............................................... 17 3/4 13 1/2 24 7/8
<CAPTION>
LOW
---------------
<S> <C>
First Quarter................................................ $13 3/4
Second Quarter............................................... 15
Third Quarter................................................ 16 3/4
Fourth Quarter............................................... 19 3/4
</TABLE>
The Company has never paid cash dividends on its Common Stock and has no
present intention to pay any cash dividends in the foreseeable future. Certain
restrictive covenants in the indentures relating to the Notes (the 'Note
Indenture'), Debentures (the 'Debentures Indenture', and collectively the
'Indentures'), the Revolving Credit Agreement and the Gold Consignment Agreement
impose limitations on the payment of dividends by the Company.
During 1997, there were no cash dividends distributed by Finlay Jewelry to
the Company. The distributions are generally utilized to pay certain expenses of
the Company such as legal, accounting and directors' fees. The Revolving Credit
Facility, the Gold Consignment Agreement and the Note Indenture currently
restrict annual distributions from Finlay Jewelry to the Company to 0.25% of
Finlay Jewelry's net sales for the preceding fiscal year.
16
<PAGE>
As of March 12, 1998, there were 9,779,703 shares of Common Stock
outstanding and approximately 66 record holders of the Common Stock, including
holders who are nominees for an undetermined number of beneficial owners,
estimated to be in excess of 500. The last reported sale price for the Common
Stock on the Nasdaq National Market on March 17, 1998 was $24.50.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial information below should be read in
conjunction with 'Management's Discussion and Analysis of Financial Condition
and Results of Operations' and the Consolidated Financial Statements and Notes
thereto. See 'Index to Consolidated Financial Statements'. The balance sheet and
statement of operations data of the Company at February 3, 1996, February 1,
1997 and January 31, 1998 and for each of the fiscal years then ended were
derived from consolidated financial statements of the Company, which statements
have been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report included elsewhere herein. The balance sheet and
statement of operations data of the Company at January 29, 1994 and January 28,
1995 and for each of the fiscal years then ended were derived from consolidated
financial statements of the Company, which statements have been audited by
Arthur Andersen LLP, independent public accountants, and which are not included
or incorporated herein.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED (1)
--------------------------------------------------------
JAN. 29, JAN. 28, FEB. 3, FEB. 1, JAN. 31,
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales........................................ $505,639 $552,090 $654,491 $685,274 $769,862
Cost of sales................................ 237,864 261,263 314,029 330,300 371,085
-------- -------- -------- -------- --------
Gross margin (2)............................. 267,775 290,827 340,462 354,974 398,777
Selling, general and administrative
expenses.................................. 223,280 240,274 282,504 290,138 324,777
Depreciation and amortization................ 8,761 8,910 9,659 10,840 12,163
Management transition and consulting expense
(3)....................................... -- 5,144 -- -- --
Nonrecurring expenses associated with
recapitalization (4)...................... 1,915 -- -- --
-------- -------- -------- -------- --------
Income (loss) from operations................ 33,819 36,499 48,299 53,996 61,837
Other nonrecurring (income)
expense (5)............................... 17,150 -- (5,000) -- --
Interest expense, net........................ 25,469 28,488 29,705 31,204 34,115
-------- -------- -------- -------- --------
Income (loss) before income taxes............ (8,800) 8,011 23,594 22,792 27,722
Provision for income taxes................... 405 5,280 9,343 11,035 12,527
-------- -------- -------- -------- --------
Net income (loss)............................ $ (9,205) $ 2,731 $ 14,251 $ 11,757 $ 15,195
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Net income (loss) applicable to common
shares.................................... $(12,799) $ (601) $ 3,534 $ 11,757 $ 15,195
Net income (loss) per share applicable to
common shares:
Basic net income (loss) per share......... $ (6.49) $ (0.27) $ 0.55 $ 1.59 $ 1.89
Diluted net income (loss) per share....... $ (6.06) $ (0.25) $ 0.53 $ 1.55 $ 1.84
Weighted average number of shares and share
equivalents outstanding (000's)........... 2,112 2,395 6,640 7,570 8,276
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
FISCAL YEAR ENDED (1)
--------------------------------------------------------
JAN. 29, JAN. 28, FEB. 3, FEB. 1, JAN. 31,
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATING AND FINANCIAL DATA:
<S> <C> <C> <C> <C> <C>
Number of Departments (end of period) (6).... 757 903 941 939 1,117
Percentage increase in sales................. 6.7% 9.2% 18.5% 4.7% 12.3%
Percentage increase in comparable Department
sales (6)(7).............................. 0.7% 4.5% 5.7% 5.9% 5.5%
Average sales per Department (6)(8).......... $ 673 $ 674 $ 710 $ 729 $ 749
EBITDA (9)................................... 42,580 45,409 57,958 64,836 74,000
EBITDA-FIFO (as adjusted) (10)............... 46,424 51,398 58,901 66,755 71,670
Capital expenditures......................... 9,150 11,228 14,933 17,533 19,338
BALANCE SHEET DATA--END OF PERIOD:
Working capital.............................. $ 21,728 $ 27,362 $ 66,395 $ 77,616 $108,395
Total assets................................. 292,112 340,764 395,145 421,273 508,236
Short-term debt, including current portion of
long-term debt............................ 1,271 576 206 2 --
Long-term debt, excluding current portion.... 194,234 201,217 202,905 211,427 221,026
Series C Preferred Stock..................... 22,096 25,428 -- --
Total stockholders' equity (deficit)......... (56,799) (57,084) 12,784 22,505 72,339
</TABLE>
- ------------------
(1) Each of the fiscal years for which information is presented includes 52
weeks except 1995, which includes 53 weeks.
(2) Finlay utilizes the LIFO method of accounting for inventories. If Finlay
had valued inventories at actual cost, as would have resulted from the
specific identification inventory valuation method, the gross margin would
have increased (decreased) as follows: $1.9 million, $0.8 million, $0.9
million, $1.9 million and $(2.3) million for 1993, 1994, 1995, 1996 and
1997, respectively.
(3) Included in 1994 are compensation and benefits for a former senior
executive totaling $3.1 million as a result of the termination of his
employment agreement and other management transition and consulting expense
totaling $2.0 million.
(4) Included in 1993 in connection with the 1993 Recapitalization is the
redemption of outstanding equity participation units in accordance with the
terms and conditions of the Company's former equity participation plan
totaling $0.9 million and bonuses totaling $1.0 million.
(5) Included in 1993 are nonrecurring expenses of $17.2 million relating to the
write-off of certain deferred financing costs and other expenses incurred
in connection with the 1993 Recapitalization. See Note 1 of Notes to
Consolidated Financial Statements of the Company. Included in 1995 are
proceeds of $5.0 million from a life insurance policy Finlay maintained
on a senior executive.
(6) Includes, beginning in 1994, Departments and stand-alone locations.
(7) Comparable Department sales are calculated by comparing the sales from
Departments open for the same months in the comparable periods.
(8) Average sales per Department is determined by dividing sales by the average
of the number of Departments open at the beginning and at the end of each
period. For 1994, the effect of the acquisition of Sonab, and subsequent
Department openings by Sonab, was prorated in determining average sales per
Department.
(9) EBITDA represents income from operations before depreciation and
amortization expenses. For 1993, EBITDA includes the effect of nonrecurring
expenses totaling $1.9 million described in Note 4 above and for 1994,
EBITDA includes the effect of management transition and consulting expense
totaling $5.1 million described in Note 3 above. The Company believes
EBITDA provides additional information for determining its ability to meet
future debt service requirements.
(10) EBITDA-FIFO(as adjusted) represents EBITDA before the LIFO provision and
before nonrecurring expenses of $1.9 million deducted in arriving at income
from operations for 1993 and management transition and consulting expense
of $5.1 million deducted in arriving at income from operations for 1994.
18
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following should be read in conjunction with 'Selected Consolidated
Financial Information' and the Consolidated Financial Statements and Notes
thereto included elsewhere in this Form 10-K.
Certain statements under this caption 'Management's Discussion and Analysis
of Financial Condition and Results of Operations' constitute 'forward-looking
statements' under the Securities Act of 1933, as amended (the 'Securities Act'),
and the Securities Exchange Act of 1934, as amended (the 'Exchange Act'). See
'Special Note Regarding Forward-Looking Statements'.
GENERAL
Since 1994, sales have increased by $217.8 million to $769.9 million, a
compound annual growth rate of 11.7%, while comparable Department sales have
increased by 5.7%, 5.9% and 5.5% in 1995, 1996 and 1997, respectively.
Comparable Department sales include Departments open for the same months during
comparable periods. The increase in total sales during this period is the result
of (i) adding 214 net new Departments and stand-alone stores, including 139
Departments from the Diamond Park Acquisition, and (ii) increasing comparable
Department sales. Management attributes its comparable Department sales
increases during this period to the following Company initiatives: (i)
introducing its 'Key Item' and 'Best Value' merchandising programs, which
provide a targeted assortment of items at competitive prices; (ii) increasing
focus on holiday and event-driven promotions as well as host store marketing
programs; (iii) positioning the Company's Departments as a 'destination
location' for fine jewelry; and (iv) implementing project PRISM (Promptly Reduce
Inefficiencies and Sales Multiply), a program designed to allow Finlay's sales
associates more time for customer sales and service.
Gross margin as a percentage of sales has decreased from 52.0% in 1995 to
51.8% in 1997. This decrease is principally the result of the Company's 'Key
Item' and 'Best Value' programs, which produce higher sales volume and a
slightly lower gross margin, on average, than other merchandise, offset, in
1997, by the favorable impact of the LIFO method of inventory. In 1997, the
Company's gross margin as a percentage of sales was unchanged as compared to
1996.
Selling, general and administrative expenses ('SG&A') as a percentage of
sales have decreased from 43.2% in 1995 to 42.2% in 1997. Management attributes
this improvement to (i) leveraging operating expenses through higher sales and
(ii) reducing the level of certain operating expenses through the ongoing
implementation of project PRISM. The components of SG&A include payroll expense,
lease fees, net advertising expenditures and other field and administrative
expenses.
As a result of the 1993 Recapitalization and the 1988 Leveraged
Recapitalization (as defined in Note 1 of Notes to Consolidated Financial
Statements), the Company is highly leveraged and, as such, interest expense had
a significant impact on the Company's results of operations. In addition, the
Company records approximately $3.0 million of goodwill amortization annually
resulting from the 1988 Leveraged Recapitalization.
Finlay entered the international fine jewelry retailing market in October
1994 by acquiring Sonab, which as of January 31, 1998 operated 155 Departments
and three stand-alone stores, principally in France. Finlay's results of
operations for 1995 reflect the first full year of Sonab's operations. In 1996,
Finlay expanded its international operations into Germany with the opening of a
Department in a new Galeries Lafayette store in Berlin.
DIAMOND PARK ACQUISITION
On October 6, 1997, Finlay completed the acquisition of certain assets of
Diamond Park, a leading operator of Departments, for approximately $63.0
million. By acquiring Diamond Park, Finlay added 139 Departments that had total
sales of $103.0 million for the twelve months ended January 31, 1998 and also
added new host store relationships with Mercantile Stores, Marshall Field's and
Parisian. Management believes that, in addition to increasing sales volume, the
Diamond Park Acquisition will
19
<PAGE>
improve Finlay's results of operations through the leveraging of expenses and
the achievement of other operating synergies.
RESULTS OF OPERATIONS
The following table sets forth operating results as a percentage of sales
for the periods indicated:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
-----------------------------------------
FEB. 3, FEB. 1, JAN. 31,
1996 1997 1998
---------- ---------- -----------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales........................................................ 100.0% 100.0% 100.0%
Cost of sales................................................ 48.0 48.2 48.2
---------- ---------- -----------
Gross margin............................................... 52.0 51.8 51.8
Selling, general and administrative expenses................. 43.2 42.3 42.2
Depreciation and amortization................................ 1.4 1.6 1.6
---------- ---------- -----------
Income (loss) from operations................................ 7.4 7.9 8.0
Other nonrecurring income(1)................................. (0.7) -- --
Interest expense, net........................................ 4.5 4.6 4.4
---------- ---------- -----------
Income (loss) before income taxes............................ 3.6 3.3 3.6
Provision (credit) for income taxes.......................... 1.4 1.6 1.6
---------- ---------- -----------
Net income (loss)............................................ 2.2% 1.7% 2.0%
---------- ---------- -----------
---------- ---------- -----------
OTHER SUPPLEMENTAL DATA:
EBITDA(2).................................................... 8.9% 9.5% 9.6%
EBITDA-FIFO (as adjusted)(3)................................. 9.0% 9.7% 9.3%
</TABLE>
- ------------------
(1) Included in other nonrecurring income for 1995 are proceeds of $5.0 million
from a life insurance policy Finlay maintained on a senior executive.
(2) EBITDA represents income from operations before depreciation and
amortization expenses. Management believes EBITDA provides additional
information for determining its ability to meet future debt service
requirements.
(3) EBITDA-FIFO (as adjusted) represents EBITDA before the LIFO provision.
1997 COMPARED WITH 1996
SALES. Sales increased $84.6 million, or 12.3%, in 1997 compared to 1996.
Comparable Department sales increased 5.5%. Management attributes this increase
in comparable Department sales primarily to the 'Key Item' and 'Best Value'
merchandising programs and to the marketing initiatives discussed above. Sales
increased $46.9 million as a result of the net new store openings, primarily due
to the acquisition of the Diamond Park Departments. During 1997, Finlay opened
188 Departments and closed ten Departments. The openings were comprised of the
following:
<TABLE>
<CAPTION>
NUMBER OF
DEPARTMENTS/
STORE GROUP STORES REASON
- ----------------------------- ------------ ---------------------------------------------------------
<S> <C> <C>
Mercantile Stores............ 90 Diamond Park Acquisition.
Marshall Field's............. 21 Diamond Park Acquisition.
Parisian..................... 28 Diamond Park Acquisition.
Monoprix..................... 16 Expansion in France.
Other........................ 33 Department openings within existing store groups.
-----
188
-----
-----
</TABLE>
These openings were offset by ten Departments closed within existing host
store groups.
GROSS MARGIN. Gross margin increased by $43.8 million in 1997 compared to
1996 and, as a percentage of sales, gross margin was unchanged compared to 1996.
During 1997, the Company benefited from a decrease in the LIFO provision as well
as the inclusion of the results of Diamond Park, which contributed $26.4 million
to the Company's gross margin, offset by management's efforts to increase market
penetration and market share through its pricing strategy.
20
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A increased $34.6 million,
or 11.9%, in 1997 compared to 1996 due primarily to payroll expense and lease
fees associated with the increase in the Company's sales. As a percentage of
sales, SG&A decreased by 0.1% in 1997 compared to 1996 as a result of the
leveraging of these expenses.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased by
$1.3 million in 1997 compared to 1996, reflecting $19.3 million in capital
expenditures for the most recent twelve months, offset by the effect of certain
assets becoming fully depreciated. The increase in fixed assets was primarily
due to the addition of new Departments and the renovation of existing
Departments.
INTEREST EXPENSE, NET. Interest expense increased by $2.9 million in 1997
compared to 1996, reflecting an increase in average borrowings ($324.6 million
for 1997 compared to $283.3 million for 1996) primarily as a result of financing
the Diamond Park Acquisition and an increase in the outstanding balance of the
Debentures due to the accretion of interest. The increase in average borrowings
was partially offset by a lower weighted average interest rate (10.1% for 1997
compared to 10.3% for 1996).
PROVISION FOR INCOME TAXES. The income tax provision for 1997 and 1996
reflects an effective tax rate of 41.5%.
NET INCOME. Net income of $15.2 million for 1997 represents an increase of
$3.4 million as compared to the net income of $11.8 million in 1996 as a result
of the factors discussed above.
1996 COMPARED WITH 1995
SALES. Sales increased $30.8 million, or 4.7%, in 1996 compared to 1995.
Comparable Department sales increased 5.9%. Management attributes this increase
in comparable Department sales primarily to the 'Key Item' and 'Best Value'
merchandising programs and to the marketing initiatives discussed above. Sales
decreased $7.8 million as a result of the net effect of new store openings
offset by store closings as well as the timing of such Department openings and
closings. During 1996, Finlay opened 84 Departments and closed 86 Departments.
The openings were comprised of the following:
<TABLE>
<CAPTION>
NUMBER OF
DEPARTMENTS/
STORE GROUP STORES REASON
- ----------------------------- ------------ ---------------------------------------------------------
<S> <C> <C>
Hecht's...................... 13 May's acquisition of Strawbridge's.
Monoprix..................... 26 Expansion in France.
Debenhams.................... 7 Departments in the United Kingdom.
New York Jewelry Outlet...... 2 Additional outlet stores.
Other........................ 36 Department openings within existing store groups.
-----
84
-----
-----
</TABLE>
The closings were comprised of the following:
<TABLE>
<CAPTION>
NUMBER OF
DEPARTMENTS/
STORE GROUP STORES REASON
- ----------------------------- ------------ ---------------------------------------------------------
<S> <C> <C>
Emporium/Weinstocks.......... 29 Acquired by Federated and integrated into Macy's.
The Jones Store Co........... 8 Lessor consolidated with one lessee.
Maison Blanche/Gayfers....... 17 Lessor consolidated with one lessee.
Other........................ 32 Department closings within existing store groups.
-----
86
-----
-----
</TABLE>
The majority of the 32 closings within existing host store groups resulted from
host store decisions to close the stores, with nine of the stores reopening at
new locations with Finlay operated Departments (including two which reopened in
1997). Ten closings resulted from Finlay's decision to close unprofitable
Departments in Steinbach stores.
GROSS MARGIN. Gross margin increased by $14.5 million in 1996 compared to
1995 but, as a percentage of sales, gross margin decreased by 0.2% primarily due
to an increase in the LIFO provision
21
<PAGE>
and to a lesser extent as a result of management's efforts to increase market
penetration and market share through its pricing strategy.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A increased $7.6 million,
or 2.7%, in 1996 compared to 1995 due primarily to payroll expense and lease
fees associated with the increase in the Company's sales. As a percentage of
sales, SG&A decreased by 0.9% in 1996 compared to 1995 as a result of the
leveraging of these expenses.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased by
$1.2 million in 1996 compared to 1995, reflecting $17.5 million in capital
expenditures for the most recent twelve months, offset by the effect of certain
assets becoming fully depreciated. The increase in fixed assets was due to the
addition of new Departments and the renovation of existing Departments.
OTHER NONRECURRING INCOME. The Company received during the second calendar
quarter of 1995, proceeds of $5.0 million from a life insurance policy
maintained on a senior executive.
INTEREST EXPENSE, NET. Interest expense increased by $1.5 million in 1996
compared to 1995 reflecting an increase in average borrowings ($283.3 million
for 1996 compared to $269.5 million for 1995) partially offset by a lower
weighted average interest rate (10.3% for 1996 compared to 10.5% for 1995).
PROVISION FOR INCOME TAXES. The income tax provision for 1996 and 1995
reflects an effective tax rate of 41.5%.
NET INCOME. Net income of $11.8 million for 1996 represents a decrease of
$2.5 million as compared to the net income of $14.3 million in 1995 as a result
of the factors discussed above. Excluding the effect of the receipt of life
insurance proceeds in 1995, net income of $11.8 million in 1996 represents an
increase of $2.5 million from $9.3 million in 1995.
LIQUIDITY AND CAPITAL RESOURCES
Finlay's primary capital requirements are for funding working capital for
new Departments and for working capital growth of existing Departments and, to a
lesser extent, capital expenditures for opening new Departments and renovating
existing Departments. For 1997, capital expenditures totaled $19.3 million,
which included construction costs related to the Company's distribution and
warehouse facility, and in 1996 totaled $17.5 million. Total capital
expenditures for 1998 are estimated to be approximately $15.0 million. Although
capital expenditures are limited by the terms of the Revolving Credit Agreement,
to date this limitation has not precluded the Company from satisfying its
capital expenditure requirements.
Finlay's operations substantially preclude customer receivables and in
recent years, on average, approximately 50% of Finlay's domestic merchandise has
been carried on consignment. Accordingly, management believes that relatively
modest levels of working capital are required in comparison to many other
retailers. The Company's working capital balance was $108.4 million at January
31, 1998, an increase of $30.8 million from February 1, 1997. The increase
resulted primarily from the net proceeds to the Company from the 1997 Offering
and the impact of 1997's net income exclusive of depreciation and amortization,
partially offset by a decrease in working capital relating to the Diamond Park
Acquisition and capital expenditures. Based on the seasonal nature of Finlay's
business, working capital requirements and therefore borrowings under the
Revolving Credit Agreement can be expected to increase on an interim basis
during the first three quarters of any given fiscal year. See '--Seasonality'.
The seasonality of Finlay's business causes working capital requirements to
reach their highest level in the months of October and November in anticipation
of the year-end holiday season. Accordingly, Finlay experiences seasonal cash
needs as inventory levels peak. The Revolving Credit Agreement presently
provides Finlay with a line of credit of up to $225.0 million to finance
seasonal cash and other working capital needs, and Finlay is in discussions to
amend the Revolving Credit Agreement to increase the line of credit thereunder
to $275.0 million and to make certain other changes thereto. There can, however,
be no assurance that the Revolving Credit Agreement will be amended as presently
contemplated or at all. Amounts outstanding under the Revolving Credit
Agreement presently bear interest at a rate equal to, at Finlay's option,
(i) the Index Rate (as defined in the Revolving Credit
22
<PAGE>
Agreement) plus 0.5% or (ii) adjusted LIBOR plus 1.5%. Commencing in late 1998,
amounts outstanding under the Revolving Credit Agreement will bear interest at
a rate equal to, at Finlay's option, (i) the Index Rate plus a margin ranging
from zero to 1.0% or (ii) adjusted LIBOR plus a margin ranging from 1.0% to
2.0%, in each case depending on the financial performance of the Company.
In each year, Finlay is required to reduce the outstanding revolving credit
balance and letter of credit balance under the Revolving Credit Agreement to
$50.0 million or less and $20.0 million or less, respectively, for a 30
consecutive day period (the 'Balance Reduction Requirement'). In addition, the
Indentures require Finlay to reduce the balance under the Revolving Credit
Agreement in each year to $10.0 million or less for a specified 25 consecutive
day period; it is anticipated by management that the indentures relating to the
Senior Debentures and Senior Notes, however, will not have a balance reduction
requirement. Borrowings under the Revolving Credit Agreement at January 31, 1998
were zero. Borrowings under the Revolving Credit Agreement were also zero at
February 1, 1997 in accordance with the then-applicable Balance Reduction
Requirement. The average amounts outstanding under the Revolving Credit
Agreement for 1996 and 1997 were $75.4 million and $107.7 million, respectively.
The maximum amount outstanding for 1997 was $189.2 million.
The Company expects to use the funds resulting from the 1997 Offering for
working capital, repayment of indebtedness or other general corporate purposes.
The Indentures restrict the Company's ability to use the net proceeds from the
1997 Offering to repay indebtedness incurred under the Revolving Credit
Agreement.
Finlay does not expect that significant additional working capital will be
required in the near-term with respect to the operation of the Diamond Park
Departments because Finlay purchased the inventory of those Diamond Park
Departments which it acquired. On a going-forward basis, Finlay expects that
inventory purchases for the Diamond Park Departments will be financed in part by
trade payables combined with an increased utilization of consignment inventory
compared to the amount of consignment merchandise on hand at the time of the
Diamond Park Acquisition. As such, management believes that future working
capital requirements for the Diamond Park Departments may be reduced as compared
to the amount of working capital required at the time of the Diamond Park
Acquisition. Finlay financed the Diamond Park Acquisition with borrowings under
the Revolving Credit Facility.
Finlay's long-term needs for external financing will depend on its 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 its vendors. As of January 31, 1998, $219.8
million of consignment merchandise from over 200 vendors was on hand as compared
to $194.3 million at February 1, 1997. For 1997, Finlay had an average balance
of consignment merchandise of $216.5 million as compared to an average balance
of $201.8 million in 1996. See 'Business--Store Relationships' and
'Business--Purchasing and Inventory'.
A substantial amount of Finlay's operating cash flow has been used or will
be required to pay, directly or indirectly, interest with respect to the
Debentures and the Notes and amounts due under the Revolving Credit Agreement,
including the payments required pursuant to the Balance Reduction Requirement
and, upon the completion of the Equity Offering and Refinancing, if consummated,
the Senior Debentures and the Senior Notes. As of January 31, 1998, Finlay's
outstanding borrowings were $221.0 million, which included an $86.0 million
balance under the Debentures and a $135.0 million balance under the Notes and,
after giving effect to the contemplated Refinancing, a $75.0 million balance
under the Senior Debentures and a $150.0 million balance under the Senior Notes.
On May 1, 1998, the Company will have a one-time option, in accordance with the
Debenture Indenture, to prepay all or a portion of the $39.0 million of accreted
interest on the Debentures as of such date. The Company intends to prepay,
subject to satisfaction of certain covenants and conditions, all such accreted
interest to reduce outstanding indebtedness and to take advantage of the
resulting tax benefits relating to the deductibility of such prepayment in 1998.
In addition, Finlay intends to redeem the outstanding principal amounts,
including associated premiums, of the Debentures and Notes approximately 30 days
following the consummation of the Equity Offering and the sale of the Senior
Debentures and Senior Notes, although there can be no assurance that Finlay will
be able to do so. Finlay intends to fund this prepayment and the redemption
using the proceeds from the contemplated
23
<PAGE>
sale of the Senior Debentures and the Equity Offering. The Debentures do not
pay cash interest until November 1, 1998. In connection with the proposed
redemption of the Debentures and the Notes, the Company expects to record,
in the quarter in which the redemption occurs, a pre-tax nonrecurring charge
of approximately $12.0 million, including $7.1 million for redemption premiums
and $3.4 million to write off deferred financing costs associated with the
Debentures and Notes.
Finlay Jewelry is party to the Gold Consignment Agreement, which expires on
May 31, 1998. The Gold Consignment Agreement enables Finlay Jewelry to receive
merchandise by providing gold, or otherwise making payment, to certain vendors.
Finlay Jewelry can obtain, pursuant to the Gold Consignment Agreement, up to the
lesser of (i) 85,000 fine troy ounces or (ii) $25.0 million worth of gold,
subject to a formula as prescribed by the Gold Consignment Agreement. At January
31, 1998, amounts outstanding under the Gold Consignment Agreement totaled
39,676 fine troy ounces, valued at approximately $12.1 million. The average
amount outstanding under the Gold Consignment Agreement was $14.3 million in
1997. Finlay Jewelry is in discussions with the cosignor under such agreement
to (i) renew the Gold Consignment Agreement through December 31, 2001,
(ii) allow Finlay Jewelry to obtain up to the lesser of (x) 85,000 fine troy
ounces or (y) $32.0 million worth of gold and (iii) make certain other
modifications. There can, however, be no assurance that the Gold Consignment
Agreement will be amended as presently contemplated or at all.
Although Finlay implemented financial and distribution software during
1997 that is Year 2000 compliant, Finlay has not yet fully assessed the impact
of the Year 2000 issue on its other computer systems and its operations,
including the development of cost estimates and the extent of computer
programming changes required to address this issue. Any disruption on its
operations, whether caused by the Company's computer systems or those of any of
its host stores or vendors, could have a material adverse effect on the
Company's financial position or results of operations. Although final cost
estimates have yet to be determined, it is anticipated that these Year 2000
costs will result in an increase in Finlay's expenses during 1998 and 1999. In
addition, there can be no assurance that the Company will not experience
significant cost overruns or delays in connection with upgrading software or the
programming of changes required to address this issue.
Section 382 of the Internal Revenue Code of 1986, as amended (the 'Code')
restricts utilization of net operating loss carryforwards ('NOLs') after an
ownership change exceeding 50%. As a result of the 1993 Recapitalization, a
change in ownership of the Company exceeding 50% occurred within the meaning of
Section 382 of the Code. Similar restrictions apply to other carryforwards.
Consequently, there is a material limitation on the Company's annual utilization
of its NOLs and other carryforwards which requires a deferral or loss of the
utilization of such NOLs or other carryforwards. The Company had, at October 31,
1997 (the Company's tax year end), a NOL for tax purposes of approximately $12.0
million which is subject to an annual limit of approximately $2.0 million per
year. For financial reporting purposes, no NOL exists as of January 31, 1998. An
additional change in ownership within the meaning of Section 382 of the Code has
occurred as a result of the 1997 Offering. However, there are no additional
restrictions upon the Company's ability to utilize its NOLs or other
carryforwards as a result of such ownership change. See Note 9 of Notes to
Consolidated Financial Statements of the Company.
On March 19, 1998, Liberty House, one of the host stores in which Finlay
operates, filed a voluntary petition under the Bankruptcy Code. The Company is
currently receiving weekly payments towards the outstanding balance of
approximately $2.0 million that was due to the Company prior to the filing of
the bankruptcy petition. Finlay believes that the bankruptcy of Liberty House
will not have a material adverse effect on Finlay's financial position or
results of operations.
From time to time, Finlay enters into futures contracts, such as options or
forwards, based upon the anticipated sales of gold product in order to hedge
against the risk arising from its payment arrangements. Changes in the market
value of futures contracts are accounted for as an addition to or reduction from
the inventory cost. For the year ended January 31, 1998, the gain or loss on
open futures contracts was not material. The Company did not have any open
positions in futures contracts for gold at January 31, 1998. There can be no
assurance that these hedging techniques will be successful or that hedging
transactions will not adversely affect the Company's results of operations or
financial position.
24
<PAGE>
Finlay believes that, based upon current operations, anticipated growth,
and increased availability under the Revolving Credit Agreement, Finlay Jewelry
will, for the foreseeable future, be able to meet its debt service and
anticipated working capital obligations, and to make distributions to the
Company sufficient to permit the Company to meet its debt service obligations
and to pay certain other expenses as they come due. No assurances, however, can
be given that Finlay Jewelry's current level of operating results will continue
or improve or that Finlay Jewelry's income from operations will continue to be
sufficient to permit Finlay Jewelry and the Company to meet their debt service
and other obligations. The principal financing arrangements currently restrict
annual distributions from Finlay Jewelry to the Company to 0.25% of Finlay
Jewelry's net sales for the preceding fiscal year. The amounts required to
satisfy the aggregate of Finlay Jewelry's interest expense and required
amortization payments totaled $21.7 million and $23.4 million for 1996 and 1997,
respectively.
SEASONALITY
Finlay's business is highly seasonal, with a significant portion of its
sales and income from operations generated during the fourth quarter of each
year, which includes the year-end holiday season. The fourth quarter accounted
for an average of 42% of Finlay's sales and 82% of its income from operations
(excluding nonrecurring charges) for 1995, 1996 and 1997. Finlay has typically
experienced net losses in the first three quarters of its fiscal year. During
these periods, working capital requirements have been funded by borrowings under
the Revolving Credit Agreement. Accordingly, the results for any of the first
three quarters of any given fiscal year, taken individually or in the aggregate,
are not indicative of annual results. See Note 11 of Notes to Consolidated
Financial Statements of the Company.
The Company's Sales and Income (loss) from operations for each quarter of
1995, 1996 and 1997 were as follows:
<TABLE>
<CAPTION>
FISCAL QUARTER
--------------------------------------------
FIRST SECOND THIRD FOURTH
-------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
1995:
Sales............................................ $112,716 $135,428 $132,058 $274,289
Income (loss) from operations.................... (1,220) 5,022 3,443 41,054
1996:
Sales............................................ 130,719 137,188 136,140 281,227
Income (loss) from operations.................... 347 6,124 4,366 43,159
1997:
Sales............................................ 134,592 148,060 148,770 338,440
Income (loss) from operations.................... 950 6,585 3,999 50,303
</TABLE>
INFLATION
The effect of inflation on Finlay's results of operations has not been
material in the periods discussed.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K ('Form 10-K') includes 'forward-looking
statements' within the meaning of Section 27A of the Securities Act and Section
21E of the Exchange Act. 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 to differ
materially from those reflected in 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', as well as trends in the general economy, competition in the
retail jewelry business, the seasonality of the retail jewelry business, the
Company's ability to increase comparable Department sales and to open new
Departments, the Company's dependence on certain host store relationships due to
the concentration of sales generated by such host stores, the availability to
the Company of alternate sources of
25
<PAGE>
merchandise supply in the case of an abrupt loss of any significant supplier,
the Company's ability to continue to obtain substantial amounts of merchandise
on consignment, the Company's dependence on key officers, the Company's ability
to integrate the Diamond Park assets (and any future acquisitions) into its
existing business, the Company's high degree of leverage and the availability
to the Company of financing and credit on favorable terms and changes in
regulatory requirements which are applicable to the Company's business.
Readers are cautioned not to rely on these forward-looking statements,
which reflect management's analysis, judgment, belief or expectation only as of
this Form 10-K. The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect events or circumstances that arise after
the date of this Form 10-K. In addition to the disclosure contained herein,
readers should carefully review any disclosure of risks and uncertainties
contained in other documents the Company files or has filed from time to time
with the Commission pursuant to the Exchange Act.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FINLAY ENTERPRISES, INC.
Report of Independent Public Accountants.................................................................. F-2
Consolidated Statements of Operations for the years ended February 3, 1996, February 1, 1997 and January
31, 1998................................................................................................ F-3
Consolidated Balance Sheets as of February 1, 1997 and January 31, 1998................................... F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended February 3, 1996, February
1, 1997 and January 31, 1998............................................................................ F-5
Consolidated Statements of Cash Flows for the years ended February 3, 1996, February 1, 1997, and January
31, 1998................................................................................................ F-6
Notes to Consolidated Financial Statements................................................................ F-7
FINLAY FINE JEWELRY CORPORATION
Report of Independent Public Accountants.................................................................. F-23
Consolidated Statements of Operations for the years ended February 3, 1996, February 1, 1997 and January
31, 1998................................................................................................ F-24
Consolidated Balance Sheets as of February 1, 1997 and January 31, 1998................................... F-25
Consolidated Statements of Changes in Stockholder's Equity for the years ended February 3, 1996, February
1, 1997 and January 31, 1998............................................................................ F-26
Consolidated Statements of Cash Flows for the years ended February 3, 1996, February 1, 1997, and January
31, 1998................................................................................................ F-27
Notes to Consolidated Financial Statements................................................................ F-28
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with the Company's
accountants on matters of accounting or financial disclosure.
26
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information with respect to each of the current
executive officers and directors of the Company and Finlay Jewelry. Each of the
persons listed as a director is a member of the Board of Directors of both the
Company and Finlay Jewelry.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------- --- ----------------------------------------------------------------------
<S> <C> <C>
David B. Cornstein................. 59 Chairman of the Company and Director
Arthur E. Reiner................... 57 President, Chief Executive Officer and Vice Chairman of the Company,
Chairman and Chief Executive Officer of Finlay Jewelry and Director
Joseph M. Melvin................... 47 Executive Vice President and Chief Operating Officer of the Company
and President and Chief Operating Officer of Finlay Jewelry
Leslie A. Philip................... 51 Executive Vice President of the Company and Executive Vice
President--Merchandising and Sales Promotion of Finlay Jewelry
Barry D. Scheckner................. 48 Senior Vice President and Chief Financial Officer of the Company and
Finlay Jewelry
Edward Stein....................... 53 Senior Vice President and Director of Stores of Finlay Jewelry
Rohit M. Desai..................... 59 Director
James Martin Kaplan................ 53 Director
Thomas H. Lee...................... 53 Director
Norman S. Matthews................. 65 Director
Hanne M. Merriman.................. 56 Director
Warren C. Smith, Jr................ 41 Director
</TABLE>
The Company, the Lee Investors, the Desai Investors, the Management
Stockholders and certain third parties are parties to a Stockholders' Agreement
that was amended prior to completion of the 1997 Offering (the 'Stockholders'
Agreement'). The Stockholders' Agreement provides, among other things, that all
parties thereto, subject to certain conditions, vote their shares to fix the
number of members of the Board of Directors of the Company at eight and to vote
in favor of six directors who will be nominated as follows: two by the Lee
Investors; one by the Desai Investors; two by Mr. Cornstein (one of whom must be
a management employee of the Company); and one by Mr. Reiner. The nomination and
election of the remaining two directors is not governed by the Stockholders'
Agreement, although the Stockholders' Agreement does require that such directors
not be parties to the Stockholders' Agreement.
Notwithstanding the foregoing, the right of various persons to designate
directors will be reduced or eliminated at such time as they own less than
certain specified percentages of the shares of Common Stock then outstanding.
Pursuant to the Stockholders' Agreement (i) Messrs. Lee and Smith were nominated
to the Board of Directors as the designees of the Lee Investors, (ii) Mr. Desai
was nominated by the Desai Investors, (iii) Messrs. Cornstein and Kaplan were
nominated by Mr. Cornstein and (iv) Mr. Reiner nominated himself.
The Stockholders' Agreement also provides that the executive committee of
the Board of Directors will consist of five directors, including one independent
director selected by the Board of Directors, one member designated by Mr. Lee
(so long as the Lee Investors have the right to designate a nominee for
director), one member designated by the Desai Investors (so long as the Desai
Investors have the right to designate a nominee for director) and two members
designated by Mr. Cornstein (which number will be reduced to one if Mr.
Cornstein is only entitled to designate one nominee for director and none if Mr.
Cornstein ceases to have the right to designate a nominee for director). The
executive committee for the Company presently consists of Messrs. Lee, Desai,
Matthews, Cornstein and Kaplan. See
27
<PAGE>
information under the caption 'Certain Relationships and Related
Transactions--Stockholders' Agreement' to be included in the Proxy Statement.
Under the Company's Restated Certificate of Incorporation, the Company's
Board of Directors is classified into three classes. The members of each class
will serve staggered three-year terms. Messrs. Desai and Lee are Class I
directors; Messrs. Cornstein, Kaplan and Reiner are Class II directors; and
Messrs. Matthews and Smith and Ms. Merriman are Class III directors. The terms
of the Class III, Class I and Class II directors expire at the annual meeting of
stockholders to be held in 1998, 1999 and 2000, respectively. Officers serve at
the discretion of the Board of Directors. Directors who are employees receive no
additional compensation for serving as members of the Board. Messrs. Lee, Desai,
Smith and Kaplan and Ms. Merriman receive no compensation for serving as
directors of the Company. Affiliates of Messrs. Lee and Desai receive fees
pursuant to the Management Agreements (as defined under the caption 'Executive
Compensation--Compensation Committee Interlocks and Insider Participation' to be
included in the Proxy Statement). Messrs. Cornstein and Reiner have employment
contracts with Finlay. See information under the caption 'Executive
Compensation--Employment Agreements and Change of Control Arrangements' to be
included in the Proxy Statement.
The business experience, principal occupations and employment of each of
the executive officers and directors of the Company and Finlay Jewelry, together
with their periods of service as directors and executive officers of the Company
and Finlay Jewelry, are set forth below.
DAVID B. CORNSTEIN has been Chairman of the Company since May 1993 and has
been a director of the Company and Finlay Jewelry since their inception in
December 1988. From December 1988 to January 1996, Mr. Cornstein was President
and Chief Executive Officer of the Company. From December 1985 to December 1988,
Mr. Cornstein was President, Chief Executive Officer and a director of a
predecessor of the Company. Mr. Cornstein is a director of What A World!, Inc.
ARTHUR E. REINER became President and Chief Executive Officer of the
Company effective January 30, 1996. He has been Vice Chairman of the Board of
the Company and Chairman of the Board and Chief Executive Officer of Finlay
Jewelry since January 3, 1995. Prior to joining Finlay, Mr. Reiner had spent
over 25 years with the Macy's organization. From February 1992 to October 1994,
Mr. Reiner was Chairman and Chief Executive Officer of Macy's East, a subsidiary
of Macy's. From 1988 to 1992, Mr. Reiner was Chairman and Chief Executive
Officer of Macy's Northeast, which was combined with Macy's Atlanta division to
form Macy's East in 1992. Mr. Reiner is also a director of Loehmann's, Inc.
JOSEPH M. MELVIN was appointed as Executive Vice President and Chief
Operating Officer of the Company and President and Chief Operating Officer of
Finlay Jewelry on May 1, 1997. From September 1975 to March 1997, Mr. Melvin
served in various positions with May, including, from 1990 to March 1997, as
Chairman of the Board and Chief Operating Officer of Filene's.
LESLIE A. PHILIP has been Executive Vice President of the Company since May
1997 and Executive Vice President--Merchandising and Sales Promotion of Finlay
Jewelry since May 1995. From 1993 to May 1995, Ms. Philip was Senior Vice
President--Advertising and Sales Promotion of Macy's, and from 1988 to 1993, Ms.
Philip was Senior Vice President--Merchandise--Fine Jewelry at Macy's. Ms.
Philip held various other positions at Macy's from 1970 to 1988.
BARRY D. SCHECKNER has been Senior Vice President and Chief Financial
Officer of Finlay Jewelry since December 1988. Mr. Scheckner has also been
Senior Vice President and Chief Financial Officer of the Company since September
1992. Prior to September 1992, he was Treasurer of the Company. From February
1983 through December 1988, Mr. Scheckner held various finance and accounting
positions with Finlay's predecessors.
EDWARD STEIN has been Senior Vice President--Director of Stores of Finlay
Jewelry since July 1995. From December 1988 to June 1995, Mr. Stein was Vice
President--Regional Supervisor of Finlay Jewelry, and occupied similar positions
with Finlay's predecessors from December 1983 to December 1988.
ROHIT M. DESAI has been a director of the Company and Finlay Jewelry since
May 1993. Mr. Desai is the founder of and, since its formation in 1984, has been
Chairman and President of Desai Capital
28
<PAGE>
Management Incorporated, a specialized equity investment management firm in New
York which manages the assets of various institutional clients, including
Equity-Linked Investors, L.P., Equity-Linked Investors-II and Private Equity
Investors III, L.P. Mr. Desai is also the managing general partner of the
general partners of each of Equity-Linked Investors, L.P. and Equity-Linked
Investors-II and the managing member of the general partner of Private Equity
Investors III, L.P. Mr. Desai serves as a director of The Rouse Company,
Sunglass Hut International, Incorporated and Independence Community Bancorp.
JAMES MARTIN KAPLAN has been a director of the Company, Finlay Jewelry and
their predecessors since 1985. Mr. Kaplan is a partner of the law firm of Tenzer
Greenblatt LLP, counsel to Finlay, which he joined in 1998. From 1977 to 1998,
Mr. Kaplan was a partner with the law firm of Zimet, Haines, Friedman & Kaplan,
former counsel to Finlay. Mr. Kaplan is also a director of What A World!, Inc.
THOMAS H. LEE has been a director of the Company and Finlay Jewelry since
May 1993. Since 1974, Mr. Lee has been President of Thomas H. Lee Company. He is
a director of First Security Services Corporation, Miller Import Corporation,
Sondik Supply Corporation, Livent Inc., Playtex Products, Inc. and Vail Resorts,
Inc.
NORMAN S. MATTHEWS has been a director of the Company and Finlay Jewelry
since July 1993. Mr. Matthews has been a retail consultant based in New York for
over six years. Prior to that time, Mr. Matthews served as President of
Federated. He is also a director of Toys 'R' Us, Inc., The Progressive
Corporation, Loehmann's, Inc. and Lechters, Inc.
HANNE M. MERRIMAN was elected a director of the Company and Finlay Jewelry
in December 1997. Ms. Merriman is the Principal in Hanne Merriman Associates, a
retail business consulting firm. Previously, she served as President of Nan
Duskin, Inc., President and Chief Executive Officer of Honeybee, Inc., a
division of Spiegel, Inc., and President of Garfinckel's, a division of Allied
Stores Corporation. She is also a director of US Airways Group, Inc., CIPSCO,
Inc. Central Illinois Public Service Company, State Farm Mutual Automobile
Insurance Company, The Rouse Company, Ann Taylor Stores Corporation and T. Rowe
Price Mutual Funds. She is a member of the National Women's Forum and a Trustee
of The American-Scandinavian Foundation. She was a member of the Board of
Directors of the Federal Reserve Bank of Richmond, Virginia from 1984 to 1990
and served as Chairman in 1989 to 1990.
WARREN C. SMITH, JR. has served as a director of the Company and Finlay
Jewelry since May 1993. Mr. Smith is a Managing Director of Thomas H. Lee
Company and has been employed by Thomas H. Lee Company since 1990. In addition,
Mr. Smith is Vice President of THL Equity Trust, a general partner of THL Equity
Advisors Limited Partnership, the general partner of Thomas H. Lee Equity
Partners, L.P. He is also a director of Rayovac Corporation.
ITEM 11. EXECUTIVE COMPENSATION
The information to be included in the section captioned 'Executive
Compensation' in the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to
beneficial ownership of the Common Stock as of March 16, 1998 by each of the
Company's directors, the Company's Chief Executive Officer and each of the four
other most highly compensated executive officers of the Company or Finlay
Jewelry, and by all directors and executive officers as a group. No other person
is known by the Company to own beneficially more than 5% of the Common Stock.
The Company owns all of the issued and outstanding capital stock of Finlay
Jewelry.
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK
BENEFICIALLY OWNED (1)
-------------------------
NUMBER OF PERCENTAGE
NAME SHARES OF CLASS
- ----------------------------------------------------------------------- --------- ----------
<S> <C> <C>
Thomas H. Lee(2)....................................................... 2,056,261 21.0%
Rohit M. Desai(3)...................................................... 704,412 7.2%
David B. Cornstein(4)(5)............................................... 529,195 5.4%
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
SHARES OF COMMON STOCK
BENEFICIALLY OWNED (1)
-------------------------
NUMBER OF PERCENTAGE
NAME SHARES OF CLASS
- ----------------------------------------------------------------------- --------- ----------
<S> <C> <C>
Arthur E. Reiner(5)(6)................................................. 179,279 1.8%
Norman S. Matthews(7).................................................. 54,000 *
Warren C. Smith, Jr.(8)................................................ 25,648 *
Leslie A. Philip(5)(9)................................................. 25,333 *
Barry D. Scheckner(5)(10).............................................. 20,200 *
Joseph M. Melvin(5)(11)................................................ 10,000 *
James Martin Kaplan(5)................................................. 4,000 *
Hanne M. Merriman...................................................... -- --
All Directors and Executive
Officers as a group
(12 persons)(12)..................................................... 3,612,997 36.2%
</TABLE>
- ------------------
* Less than one percent.
(1) The persons named in the table have sole voting and investment power with
respect to all shares of Common Stock subject to the terms of the
Stockholders' Agreement.
(2) Includes 1,801,510 shares of Common Stock held of record by Thomas H. Lee
Equity Partners, L.P. ('THLEP'), the general partner of which is THL Equity
Advisors Limited Partnership, a Massachusetts limited partnership of which
Mr. Lee is a general partner, and 254,751 shares of Common Stock held of
record by 1989 Thomas H. Lee Nominee Trust (the 'Nominee Trust'), 53,259
shares of which are subject to options granted to others. Mr. Lee's address
is c/o Thomas H. Lee Company, L.L.C., 590 Madison Avenue, New York, New
York 10022.
(3) Includes 704,412 shares of Common Stock held of record by Equity-Linked
Investors-II ('ELI-II'). ELI-II is a limited partnership, the general
partners of which are Rohit M. Desai Associates and Rohit M. Desai
Associates-II (together, the 'General Partners'), respectively. As general
partners, the General Partners have the power to vote and dispose of these
securities. Rohit M. Desai is the managing general partner of each of the
General Partners. Mr. Desai is also the sole stockholder, chairman of the
board and president of Desai Capital Management Incorporated ('DCMI'),
which acts as an investment advisor to ELI-II. Under the investment
advisory agreements between DCMI and ELI-II, decisions as to the voting or
disposition of these securities may be made by DCMI. DCMI and Mr. Desai
disclaim beneficial ownership of the securities. The address of Mr. Desai
and ELI-II is c/o Desai Capital Management Incorporated, 540 Madison
Avenue, New York, New York 10022.
(4) Includes options to acquire 53,333 shares of Common Stock granted in 1995
having an exercise price of $14.00 per share.
(5) The address of Messrs. Cornstein, Reiner, Kaplan, Melvin, Scheckner and
Stein and Ms. Philip is in care of the Company, 529 Fifth Avenue, New York,
New York 10017.
(6) Includes options to acquire 34,632 shares of Common Stock granted in 1994
having an exercise price of $14.00 per share. In accordance with applicable
Commission rules, does not include 334,631 shares subject to options not
exercisable within 60 days.
(7) Includes options to acquire 13,333 shares of Common Stock granted in 1993
having an exercise price of $12.00 per share, options to acquire 13,334
shares of Common Stock granted in 1993 having an exercise price of $16.50
per share, options to acquire 13,334 shares of Common Stock granted in 1995
having an exercise price of $14.00 per share and options to acquire 10,000
shares of Common Stock granted in 1996 having an exercise price of $11.16
per share and options to acquire 4,000 shares of Common Stock granted in
1997 having an exercise price of $13.875 per share. Mr. Matthew's address
is 650 Madison Avenue, New York, New York 10022.
(8) Includes options to acquire 11,064 shares from the Nominee Trust. Mr.
Smith's address is c/o Thomas H. Lee Company, 75 State Street, Boston,
Massachusetts 02109.
(9) Includes options to acquire 20,000 shares of Common Stock granted in 1995
having an exercise price of $11.19 per share and options to acquire 5,333
shares of Common Stock granted in 1997 having and exercise price of $13.875
per share.
(10) Includes options to acquire 9,600 shares of Common Stock granted in 1993
having an exercise price of $7.23 per share, options to acquire 6,000
shares of Common Stock granted in 1995 having an exercise price of $14.00
per share and options to acquire 2,600 shares of Common Stock granted in
1997 having an exercise price of $13.875 per share.
(11) Includes options to acquire 10,000 shares of Common Stock granted in 1997
having an exercise price of $14.875 per share.
(12) Includes options to acquire 210,232 shares having exercise prices ranging
from $7.23 to $16.50 per share.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information to be included in the section captioned 'Certain
Relationships and Related Transactions' in the Proxy Statement is incorporated
herein by reference.
30
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
(1) Financial Statements.
See Financial Statements Index included in Item 8 of Part II of this Form
10-K.
(2) Financial Statement Schedules. Consolidated Financial Statements of
Finlay Jewelry.
(3) Exhibits.
(Exhibit Number referenced to Item 601 of Regulation S-K).
<TABLE>
<CAPTION>
ITEM
NUMBER
- --------
<S> <C> <C>
3.1 -- Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1
filed as part of the Annual Report on Form 10-K for the period ended January 28, 1995 filed by the
Company on April 12, 1995).
3.2 -- Amended and Restated By-laws of the Company (incorporated by reference to Exhibit 3.2 of Form S-1
Registration Statement, Registration No. 33-88938).
4.1 -- Article Fourth of the Restated Certificate of Incorporation and Articles II and VI of the Amended
and Restated Bylaws (incorporated by reference to Exhibit 4.1 of Form S-1 Registration Statement,
Registration No. 33-88938).
4.2 -- Specimen Common Stock certificate (incorporated by reference to Exhibit 4.2 of Form S-1
Registration Statement, Registration No. 33-88938).
4.3 -- Specimen 12% Senior Discount Debenture Due 2005 issued by the Company (incorporated by reference to
Exhibit 4.3 filed as part of the Current Report on Form 8-K filed by the Company on June 10, 1993).
4.4(a) -- Indenture dated as of May 26, 1993 between the Company and Marine Midland Bank, as Trustee,
relating to the 12% Senior Discount Debenture Due 2005 issued by the Company (incorporated by
reference to Exhibit 4.4 filed as part of the Current Report on Form 8-K filed by the Company on
June 10, 1993).
4.4(b) -- First Supplemental Indenture dated as of October 28, 1994 among the Company, Sonab Holdings, Inc.
('Sonab Holdings'), Sonab International, Inc. ('Sonab International'), Sonab and Marine Midland
Bank, as Trustee, to the indenture relating to the 12% Senior Discount Debentures due 2005 issued
by the Company (incorporated by reference to Exhibit 4.1 filed as part of the Quarterly Report on
Form 10-Q for the period ended October 29, 1994 filed by the Company on December 13, 1994).
4.4(c) -- Second Supplemental Indenture, dated as of July 14, 1995, among the Company, Sonab Holdings, Sonab
International, Sonab and Marine Midland Bank, as trustee, to the indenture relating to the 12%
Senior Discount Debentures due 2005 issued by the Company (incorporated by reference to Exhibit 4.1
filed as part of the Quarterly Report on Form 10-Q for the period ended July 29, 1995 filed by the
Company on September 9, 1995).
4.5 -- Pledge Agreement between the Company, and Marine Midland Bank, as Pledgee, dated as of May 26, 1993
(incorporated by reference to exhibit 10.NN filed as part of the Annual Report for the period ended
January 29, 1994 filed by the Company on Form 10-K on April 27, 1994).
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
ITEM
NUMBER
- --------
<S> <C> <C>
4.6 -- Specimen 10 5/8% Senior Note Due 2003 issued by Finlay Jewelry (incorporated by reference to
Exhibit 4.2 filed as part of the Current Report on Form 8-K filed by Finlay Jewelry on June 10,
1993).
4.7(a) -- Indenture dated as of May 26, 1993 between Finlay Jewelry and Marine Midland Bank, as Trustee,
relating to the 10 5/8% Senior Notes Due 2003 issued by Finlay Jewelry (incorporated by reference
to Exhibit 4.3 filed as part of the Current Report on Form 8-K filed by Finlay Jewelry on June 10,
1993).
4.7(b) -- First Supplemental Indenture dated as of October 28, 1994 among Finlay Jewelry, Sonab Holdings,
Sonab International, Sonab and Marine Midland Bank, as Trustee, to the indenture relating to the
10 5/8% Senior Notes Due 2003 issued by Finlay Jewelry (incorporated by reference to Exhibit 4.1
filed as part of the Quarterly Report on Form 10-Q for the period ended October 29, 1994 filed by
Finlay Jewelry on December 13, 1994).
4.7(c) -- Second Supplemental Indenture, dated as of July 14, 1995, among Finlay Jewelry, Sonab Holdings,
Sonab International, Sonab and Marine Midland Bank, as trustee, to the indenture relating to the
10 5/8% Senior Notes due 2003 issued by Finlay Jewelry (incorporated by reference to Exhibit 4.1
filed as part of the Quarterly Report on Form 10-Q for the period ended July 29, 1995 filed by
Finlay Jewelry on September 9, 1995).
4.8 -- Stock Purchase Agreement dated as of May 26, 1993 among the Company, Finlay Jewelry, THL Equity
Holding Corp., Equity-Linked Investors, L.P. and Equity-Linked Investors-II (incorporated by
reference to Exhibit 4.5 filed as part of the Current Report on Form 8-K filed by the Company on
June 10, 1993).
4.9 -- Amended and Restated Stockholders' Agreement dated as of March 6, 1995 among the Company, David B.
Cornstein, Arthur E. Reiner, Robert S. Lowenstein, Norman S. Matthews, Ronald B. Grudberg, Harold
S. Geneen, James Martin Kaplan, Electra Investment Trust, PLC, RHI Holdings, Inc., Jeffrey Branman,
The Lee Holders listed on the signature page thereto, Equity-Linked Investors, L.P., Equity-Linked
Investors-II and certain other security holders (incorporated by reference to Exhibit 4.9 filed as
part of the Annual Report on Form 10-K for the period ended January 28, 1995 filed by the Company
on April 12, 1995).
4.10 -- Registration Rights Agreement dated as of May 26, 1993 among the Company, David B. Cornstein,
Harold S. Geneen, Ronald B. Grudberg, Robert S. Lowenstein, John C. Belknap, James Martin Kaplan,
Electra Investment Trust, PLC, RHI Holdings, Inc., Jeffrey Branman, Andrew U. Belknap, Timothy H.
Belknap, THL Equity Holding Corp., Equity-Linked Investors, L.P. and Equity-Linked Investors-II
(incorporated by reference to Exhibit 4.7 filed as part of the Current Report on Form 8-K filed by
the Company on June 10, 1993).
4.11 -- Omnibus Amendment to Registration Rights and Stockholders' Agreements (incorporated by reference to
Exhibit 10.10 to the Company's Quarterly Report on Form 10-Q for the period ended November 1, 1997
filed by the Company on December 16, 1997.
10.1 -- Underwriting Agreement relating to the Offering dated April 6, 1995 by and among the Company,
Finlay Jewelry, the Selling Stockholders and Goldman, Sachs & Co. on behalf of each of the
Underwriters (incorporated by reference to Exhibit 10.1 filed as part of the Annual Report on Form
10-K for the period ended January 28, 1995 filed by the Company on April 12, 1995).
10.2 -- Form of Agreement and Certificate of Option Pursuant to the Long Term Incentive Plan of the Company
(incorporated by reference to Exhibit 10.1 filed as part of the Quarterly
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
ITEM
NUMBER
- --------
<S> <C> <C>
Report on Form 10-Q for the period ended July 31, 1993 filed by the Company on September 14, 1993).
10.3 -- The Company's Restated Retirement Income Plan (401(k)) (incorporated by reference to Exhibit 10.6
filed as part of the Quarterly Report on Form 10-Q for the period ended July 29, 1995 filed by the
Company on September 9, 1995).
10.3(a) -- Amendment No. 1 to the Company's Restated Retirement Income Plan (401(k)) (incorporated by
reference to Exhibit 10.7 filed as part of the Quarterly Report on Form 10-Q for the period ended
July 29, 1995 filed by the Company on September 9, 1995).
10.3(b) -- Amendment No. 2 to the Company's Retirement Income Plan (incorporated by reference to Exhibit 10.1
filed as part of the Quarterly Report on Form 10-Q for the period ended May 4, 1996 filed by the
Company on June 14, 1996).
10.3(c) -- Amendment No. 3 to the Company's Restated Retirement Income Plan (401(k)) (incorporated by
reference to Exhibit 10.11 filed as part of the Quarterly Report on Form 10-Q for the period ended
November 1, 1997 filed by the Company on December 16, 1997).
10.4 -- Executive Medical Benefits Plan of Finlay Jewelry and the Company (incorporated by reference to
Exhibit 10.7 of Form S-1 Registration Statement, Registration No. 33-59434).
10.5(a) -- Employment Agreement dated as of May 26, 1993 between David B. Cornstein and Finlay Jewelry
(incorporated by reference to Exhibit 19.2 filed as part of the Quarterly Report on Form 10-Q for
the period ended May 1, 1993 filed by the Company on June 30, 1993).
10.5(b) -- Amendment to Employment Agreement dated as of December 20, 1995 between David B. Cornstein and
Finlay Jewelry (incorporated by reference to Exhibit 10.1 filed as part of the Quarterly Report on
Form 10-Q for the period ended April 29, 1995 filed by the Company on June 3, 1995).
10.5(c) -- Amendment to Employment Agreement between David B. Cornstein and Finlay (incorporated by reference
to Exhibit 10.9 filed as part of the Quarterly Report on Form 10-Q for the period ended November 1,
1997 filed by the Company on December 16, 1997).
10.6(a) -- Employment Agreement dated as of January 3, 1995 among the Company, Finlay Jewelry and Arthur E.
Reiner (incorporated by reference to Exhibit 10.7(a) of Form S-1 Registration Statement,
Registration No. 33-88938).
10.6(b) -- Executive Securities Purchase Agreement dated as of January 3, 1995 between the Company and Arthur
E. Reiner (incorporated by reference to Exhibit 10.7(b) of Form S-1 Registration Statement,
Registration No. 33-88938).
10.6(c) -- Limited Recourse Secured Promissory Note dated as of January 3, 1995 by Arthur E. Reiner in favor
of the Company (incorporated by reference to Exhibit 10.7(c) of Form S-1 Registration Statement,
Registration No. 33-88938).
10.6(d) -- Stock Pledge Agreement dated as of January 3, 1995 between the Company and Arthur E. Reiner
(incorporated by reference to Exhibit 10.7(d) of Form S-1 Registration Statement, Registration No.
33-88938).
10.6(e) -- Amendment Employment Agreement dated as of May 17, 1995 among the Company, Finlay Jewelry and
Arthur E. Reiner (incorporated by reference to Exhibit 10.8(e) filed as part of the Annual Report
on Form 10-K for the period ended February 1, 1997 filed by the Company on May 1, 1997).
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
ITEM
NUMBER
- --------
<S> <C> <C>
10.6(f) -- Amendment No. 2 to Employment Agreement dated as of March 5, 1997 among the Company, Finlay Jewelry
and Arthur E. Reiner (incorporated by reference to Exhibit 10 filed as part of the Quarterly Report
on Form 10-Q for the period ended May 3, 1997 filed by the Company on June 17, 1997).
10.6(g) -- Amendment No. 3 to Employment Agreement dated as of July 1, 1997 among the Company, Finlay Jewelry
and Arthur E. Reiner (incorporated by reference to Exhibit 10.7(g) of Form S-1 Registration
Statement, Registration No. 333-34949).
10.7(a) -- Consulting and Option Agreement dated as of July 7, 1993 by and between Finlay Jewelry and Norman
S. Matthews (incorporated by reference to Exhibit 10.OO filed as part of the Annual Report on Form
10-K for the period ended January 29, 1994 filed by the Company on April 27, 1994).
10.7(b) -- Amendment to Consulting and Option Agreement dated as of March 6, 1995 between Norman S. Matthews
and Finlay Jewelry (incorporated by reference to Exhibit 10.2 filed as part of the Quarterly Report
on Form 10-Q for the period ended April 29, 1995 filed by the Company on June 3, 1995).
10.8 -- Employment Agreement dated as of April 18, 1997 between Joseph M. Melvin and Finlay Jewelry
(incorporated by reference to Exhibit 10.9 of Form S-1 Registration Statement, Registration No.
333-34949).
10.9 -- Tax Allocation Agreement dated as of November 1, 1992 between the Company and Finlay Jewelry
(incorporated by reference to Exhibit 19.5 filed as part of the Quarterly Report on Form 10-Q for
the period ended May 1, 1993 filed by the Company on June 30, 1993).
10.10 -- Management Agreement dated as of May 26, 1993 among the Company, Finlay Jewelry and Thomas H. Lee
Company (incorporated by reference to Exhibit 28.2 filed as part of the Current Report on Form 8-K
filed by the Company on June 10, 1993).
10.11 -- Management Agreement dated as of May 26, 1993 among the Company, Finlay Jewelry and Desai Capital
Management Incorporated (incorporated by reference to Exhibit 28.1 filed as part of the Current
Report on Form 8-K filed by the Company on June 10, 1993).
10.12(a) -- Long Term Incentive Plan of the Company (incorporated by reference to Exhibit 19.6 filed as part of
the Quarterly Report on Form 10-Q for the period ended May 1, 1993 filed by the Company on June 30,
1993).
10.12(b) -- Amendment No. 1 to the Company's Long Term Incentive Plan (incorporated by reference to Exhibit
10.14(b) of the Form S-1 Registration Statement, Registration No. 33-88938).
10.13 -- 1997 Long Term Incentive Plan (incorporated by reference to Exhibit 10.13(c) of Form S-1
Registration Statement, Registration No. 333-34949).
10.14(a) -- Amended and Restated Credit Agreement dated as of March 28, 1995 among GE Capital, individually and
its capacity as agent, certain other lenders and financial institutions, the Company and Finlay
Jewelry (the 'Amended and Restated Credit Agreement') (incorporated by reference to Exhibit 10.15
filed as part of the Annual Report on Form 10-K for the period ended January 28, 1995 filed by the
Company on April 12, 1995).
10.14(b) -- Amendment No. 1, dated as of June 15, 1995, to the Amended and Restated Credit Agreement
(incorporated by reference to Exhibit 10.4 filed as part of the Quarterly Report on Form 10-Q for
the period ended July 29, 1995 filed by Finlay Jewelry on September 9, 1995).
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
ITEM
NUMBER
- --------
<S> <C> <C>
10.14(c) -- Amendment No. 2 to the Amended and Restated Credit Agreement dated as of February 1, 1996
(incorporated by reference to Exhibit 10.15(c) filed as part of the Annual Report on Form 10-K for
the period ended February 3, 1996 filed by the Company on April 9, 1996).
10.14(d) -- Amendment No. 3 to the Amended and Restated Credit Agreement dated as of January 31, 1997
(incorporated by reference to Exhibit 10.1 filed as part of the Quarterly Report on Form 10-Q for
the period ended August 2, 1997 filed by the Company on September 16, 1997).
10.15(a) -- Amended and Restated Revolving Note dated as of March 28, 1995 by the Company and Finlay Jewelry to
the order of GE Capital in the principal amount of $98,000,000 (incorporated by reference to
Exhibit 10.16(a) filed as part of the Annual Report on Form 10-K for the period ended January 28,
1995 filed by the Company on April 12, 1995).
10.15(b) -- Amended and Restated Revolving Note dated as of March 28, 1995 by the Company and Finlay Jewelry to
the order of Shawmut Bank in the principal amount of $37,000,000 (incorporated by reference to
Exhibit 10.16(b) filed as part of the Annual Report on Form 10-K for the period ended January 28,
1995 filed by the Company on April 12, 1995).
10.16 -- Security Agreement dated as of May 26, 1993 by Finlay Jewelry in favor of GE Capital, as agent
(incorporated by reference to Exhibit 19.9 filed as part of the Quarterly Report on Form 10-Q for
the period ended May 1, 1993 filed by the Company on June 30, 1993).
10.17 -- Security Agreement and Mortgage--Trademarks, Patents and Copyrights, dated as of May 26, 1993 by
Finlay Jewelry in favor of GE Capital, as agent (incorporated by reference to Exhibit 19.10 filed
as part of the Quarterly Report on Form 10-Q for the period ended May 1, 1993 filed by the Company
on June 30, 1993).
10.18 -- Assignment of Life Insurance Policy as Collateral dated May 26, 1993 by the Company to GE Capital,
as agent (upon the life of each David B. Cornstein, Ronald B. Grudberg and Robert S. Lowenstein)
(incorporated by reference to Exhibit 19.11 filed as part of the Quarterly Report on Form 10-Q for
the period ended May 1, 1993 filed by the Company on June 30, 1993).
10.19 -- Assignment of Business Interruption Insurance Policy as Collateral dated February 28, 1994 by
Finlay Jewelry to GE Capital, as agent (incorporated by reference to Exhibit 10.M filed as part of
the Annual Report on Form 10-K for the period ended January 29, 1994 filed by the Company on April
27, 1994).
10.20(a) -- Guarantee dated as of May 26, 1993 by Finlay Jewelry, Inc. to GE Capital, as agent (incorporated by
reference to Exhibit 19.13 filed as part of the Quarterly Report on Form 10-Q for the period ended
May 1, 1993 filed by the Company on June 30, 1993).
10.20(b) -- Guarantee dated as of October 28, 1994 by Sonab Holdings in favor of GE Capital (incorporated by
reference to Exhibit 10.5 filed as part of the Quarterly Report on Form 10-Q for the period ended
October 29, 1994 filed by the Company on December 13, 1994).
10.20(c) -- Guarantee dated as of October 28, 1994 by Sonab International in favor of GE Capital (incorporated
by reference to Exhibit 10.6 filed as part of the Quarterly Report on Form 10-Q for the period
ended October 29, 1994 filed by the Company on December 13, 1994).
10.20(d) -- Guarantee dated as of October 28, 1994 by Sonab in favor of GE Capital (incorporated by reference
to Exhibit 10.7 filed as part of the Quarterly Report on
</TABLE>
35
<PAGE>
<TABLE>
<CAPTION>
ITEM
NUMBER
- --------
<S> <C> <C>
Form 10-Q for the period ended October 29, 1994 filed by the Company on December 13, 1994).
10.21(a) -- Pledge Agreement dated as of May 26, 1993 by Finlay Jewelry to GE Capital, as agent (incorporated
by reference to Exhibit 19.14 filed as part of the Quarterly Report on Form 10-Q for the period
ended October 29, 1994 filed by the Company on December 13, 1994).
10.21(b) -- Amendment Agreement dated October 28, 1994 to the Pledge Agreement by Finlay Jewelry in favor of GE
Capital (incorporated by reference to Exhibit 10.8 filed as part of the Quarterly Report on Form
10-Q for the period ended October 29, 1994 filed by the Company on December 13, 1994).
10.22(a) -- Share Pledge Agreement (Translation) dated October 28, 1994 by Sonab Holdings in favor of GE
Capital (incorporated by reference to Exhibit 10.9 filed as part of the Quarterly Report on Form
10-Q for the period ended October 29, 1994 filed by the Company on December 13, 1994).
10.22(b) -- Share Pledge Agreement (Translation) dated October 28, 1994 by Sonab International in favor of GE
Capital (incorporated by reference to Exhibit 10.10 filed as part of the Quarterly Report on Form
10-Q for the period ended October 29, 1994 filed by the Company on December 13, 1994).
10.23 -- Master Agreement for the Assignment of Accounts Receivable as Security (Translation) dated October
28, 1994 by Sonab in favor of GE Capital (incorporated by reference to Exhibit 10.11 filed as part
of the Quarterly Report on Form 10-Q for the period ended October 29, 1994 filed by the Company on
December 13, 1994).
10.24 -- Note Pledge Agreement dated as of October 28, 1994 by Finlay Jewelry in favor of GE Capital
(incorporated by reference to Exhibit 10.12 filed as part of the Quarterly Report on Form 10-Q for
the period ended October 29, 1994 filed by the Company on December 13, 1994).
10.25(a) -- Amended and Restated Credit Agreement dated as of September 11, 1997 among G. E. Capital,
individually and in its capacity as agent, certain other lenders and financial institutions, the
Company and Finlay Jewelry ('Amended Revolving Credit Agreement') (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the period ended August 2, 1997
filed by the Company on September 16, 1997).
10.25(b) -- Amendment No. 1 dated as of September 11, 1997 to the Amended Revolving Credit Agreement
(incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the
period ended August 2, 1997 filed by the Company on September 16, 1997).
10.25(c) -- Amendment No. 2 dated October 6, 1997 to the Amended Revolving Credit Agreement (incorporated by
reference to Exhibit 10.25 (c) to the Company's Registration Statement on Form S-1 (Registration
No. 333-34949)).
10.26 -- Share Purchase Agreement dated as of October 28, 1994 among Societe Des Grands Magasins Galeries
Lafayette, Union Pour Les Investissements Commerciaux, Societe Anonyme Des Galeries Lafayette,
Sonab Holdings and Sonab International (incorporated by reference to Exhibit 10.1 filed as part of
the Quarterly Report on Form 10-Q for the period ended October 29, 1994 filed by the Company on
December 13, 1994).
10.27 -- Form of Officer's and Director's Indemnification Agreement (incorporated by reference to Exhibit
10.4 filed as part of the Quarterly Report on Form 10-Q for the period ended April 29, 1995 filed
by the Company on June 3, 1995).
</TABLE>
36
<PAGE>
<TABLE>
<CAPTION>
ITEM
NUMBER
- --------
<S> <C> <C>
10.28(a) -- Gold Consignment Agreement dated as of June 15, 1995 (the 'Gold Consignment Agreement') between
Finlay Jewelry and Rhode Island Hospital Trust National Bank ('RIHT') (incorporated by reference to
Exhibit 10.1 filed as part of the Quarterly Report on Form 10-Q for the period ended July 29, 1995
filed by the Company on September 9, 1995).
10.28(b) -- Amendment No. 1 and Limited Consent to the Gold Consignment Agreement (incorporated by reference to
Exhibit 10.31(b) filed as part of the Annual Report on Form 10-K for the period ended February 3,
1996 filed by the Company on April 9, 1996).
10.28(c) -- Amendment No. 2 and Limited Consent dated as of September 10, 1997 to the Gold Consignment
Agreement, as amended, by and between Finlay Jewelry and RIHT (incorporated by reference to Exhibit
10.4 to the Company's Quarterly Report on Form 10-Q for the period ended August 2, 1997 filed by
the Company on September 16, 1997).
10.28(d) -- Amendment No. 3 and Limited Consent dated as of September 11, 1997 to the Gold Consignment
Agreement, as amended, by and between Finlay Jewelry and RIHT (incorporated by reference to Exhibit
10.5 to the Company's Quarterly Report on Form 10-Q for the period ended August 2, 1997 filed by
the Company on September 16, 1997).
10.28(e) -- Amendment No. 4 and Limited Consent dated as of October 6, 1997 to the Gold Consignment Agreement,
as amended, by and between Finlay Jewelry and RIHT (incorporated by reference to Exhibit 10.29 (e)
to the Company's Registration Statement on Form S-1 (Registration No. 333-34949)).
10.29 -- Security Agreement dated as of June 15, 1995 between Finlay Jewelry and RIHT (incorporated by
reference to Exhibit 10.2 filed as part of the Quarterly Report on Form 10-Q for the period ended
July 29, 1995 filed by the Company on September 9, 1995).
10.30 -- Cash Collateral Agreement dated as of June 15, 1995 between Finlay Jewelry and RIHT (incorporated
by reference to Exhibit 10.3 filed as part of the Quarterly Report on Form 10-Q for the period
ended July 29, 1995 filed by the Company on September 9, 1995).
10.31 -- Intercreditor Agreement dated as of June 15, 1995 between GE Capital and RIHT and acknowledged by
Finlay Jewelry (incorporated by reference to Exhibit 10.5 filed as part of the Quarterly Report on
Form 10-Q for the period ended July 29, 1995 filed by the Company on September 9, 1995).
10.32 -- Asset Purchase Agreement dated September 3, 1997 by and among the Company, Finlay Jewelry, Zale
Corporation and Zale Delaware, Inc (incorporated by reference to Exhibit 10.6 to the Company's
Quarterly Report on Form 10-Q for the period ended August 2, 1997 filed by the Company on September
16, 1997).
11.1 -- Computation of earnings per share.
21.1 -- Subsidiaries of the Company (incorporated by reference to Exhibit 21.1 of Form S-1 Registration
Statement, Registration No. 33-88938).
23.1 -- Consent of Independent Auditors.
27 -- Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1997.
37
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) 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.
FINLAY ENTERPRISES, INC.
Date: March 24, 1998 By: /s/ DAVID B. CORNSTEIN
----------------------------------
David B. Cornstein
Chairman of the Board
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED:
<TABLE>
<CAPTION>
NAME TITLE DATE
- ------------------------------------------ ---------------------------------------- -------------------
<S> <C> <C>
/s/ DAVID B. CORNSTEIN Chairman of the Board and Director March 24, 1998
- ------------------------------------------
David B. Cornstein
/s/ ARTHUR E. REINER President, Chief Executive Officer, March 24, 1998
- ------------------------------------------ Vice Chairman and Director (Principal
Arthur E. Reiner Executive Officer)
/s/ BARRY D. SCHECKNER Senior Vice President and Chief March 24, 1998
- ------------------------------------------ Financial Officer (Principal Financial
Barry D. Scheckner Officer)
/s/ BRUCE E. ZURLNICK Treasurer (Principal Accounting Officer) March 24, 1998
- ------------------------------------------
Bruce E. Zurlnick
/s/ NORMAN S. MATTHEWS Director March 24, 1998
- ------------------------------------------
Norman S. Matthews
/s/ JAMES MARTIN KAPLAN Director March 24, 1998
- ------------------------------------------
James Martin Kaplan
/s/ ROHIT M. DESAI Director March 24, 1998
- ------------------------------------------
Rohit M. Desai
/s/ THOMAS H. LEE Director March 24, 1998
- ------------------------------------------
Thomas H. Lee
/s/ WARREN C. SMITH, JR. Director March 24, 1998
- ------------------------------------------
Warren C. Smith, Jr.
/s/ HANNE M. MERRIMAN Director March 24, 1998
- ------------------------------------------
Hanne M. Merriman
</TABLE>
38
<PAGE>
FINLAY ENTERPRISES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FINLAY ENTERPRISES, INC.
Report of Independent Public Accountants.................................................................. F-2
Consolidated Statements of Operations for the years ended February 3, 1996,
February 1, 1997 and January 31, 1998................................................................... F-3
Consolidated Balance Sheets as of February 1, 1997 and January 31, 1998................................... F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended
February 3, 1996, February 1, 1997 and January 31, 1998................................................. F-5
Consolidated Statements of Cash Flows for the years ended February 3, 1996,
February 1, 1997 and January 31, 1998................................................................... F-6
Notes to Consolidated Financial Statements................................................................ F-7
FINLAY FINE JEWELRY CORPORATION
Report of Independent Public Accountants.................................................................. F-23
Consolidated Statements of Operations for the years ended February 3, 1996,
February 1, 1997 and January 31, 1998................................................................... F-24
Consolidated Balance Sheets as of February 1, 1997 and January 31, 1998................................... F-25
Consolidated Statements of Changes in Stockholder's Equity for the years ended
February 3, 1996, February 1, 1997 and January 31, 1998................................................. F-26
Consolidated Statements of Cash Flows for the years ended February 3, 1996,
February 1, 1997 and January 31, 1998................................................................... F-27
Notes to Consolidated Financial Statements................................................................ F-28
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Stockholders and Board of Directors
of Finlay Enterprises, Inc.:
We have audited the accompanying consolidated balance sheets of Finlay
Enterprises, Inc. (a Delaware corporation) and subsidiaries as of February 1,
1997 and January 31, 1998, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for the fifty-three
weeks ended February 3, 1996, the fifty-two weeks ended February 1, 1997 and the
fifty-two weeks ended January 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Finlay Enterprises, Inc. and
subsidiaries as of February 1, 1997 and January 31, 1998, and the results of
their operations and their cash flows for the fifty-three weeks ended February
3, 1996, the fifty-two weeks ended February 1, 1997 and the fifty-two weeks
ended January 31, 1998, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
New York, New York
March 18, 1998
F-2
<PAGE>
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Sales............................................................... $ 654,491 $ 685,274 $ 769,862
Cost of sales....................................................... 314,029 330,300 371,085
----------- ----------- -----------
Gross margin...................................................... 340,462 354,974 398,777
Selling, general and administrative expenses........................ 282,504 290,138 324,777
Depreciation and amortization....................................... 9,659 10,840 12,163
----------- ----------- -----------
Income (loss) from operations..................................... 48,299 53,996 61,837
Proceeds from life insurance........................................ (5,000) -- --
Interest expense, net............................................... 29,705 31,204 34,115
----------- ----------- -----------
Income (loss) before income taxes................................. 23,594 22,792 27,722
Provision (credit) for income taxes................................. 9,343 11,035 12,527
----------- ----------- -----------
Net income (loss)................................................. 14,251 11,757 15,195
Dividends on Preferred Stock and accretion on conversion of
Preferred Stock................................................... 10,717 -- --
----------- ----------- -----------
Net income (loss) applicable to common shares....................... $ 3,534 $ 11,757 $ 15,195
----------- ----------- -----------
----------- ----------- -----------
Net income (loss) per share applicable to common shares:
Basic net income (loss) per share................................. $ 0.55 $ 1.59 $ 1.89
----------- ----------- -----------
----------- ----------- -----------
Diluted net income (loss) per share............................... $ 0.53 $ 1.55 $ 1.84
----------- ----------- -----------
----------- ----------- -----------
Weighted average shares and share equivalents outstanding........... 6,639,727 7,569,529 8,275,934
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
FINLAY ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 20,846 $ 13,588
Accounts receivable--department stores.............................................. 15,362 20,772
Other receivables................................................................... 4,350 6,862
Merchandise inventories............................................................. 222,445 279,766
Prepaid expenses and other.......................................................... 1,437 1,781
----------- -----------
Total current assets............................................................. 264,440 322,769
----------- -----------
Fixed assets
Equipment, fixtures and leasehold improvements...................................... 73,223 95,257
Less--accumulated depreciation and amortization..................................... 21,423 28,249
----------- -----------
Fixed assets, net................................................................ 51,800 67,008
----------- -----------
Deferred charges and other assets..................................................... 9,770 14,188
Goodwill.............................................................................. 95,263 104,271
----------- -----------
Total assets..................................................................... $ 421,273 $ 508,236
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt................................................... $ 2 $ --
Accounts payable--trade............................................................. 133,252 160,434
Accrued liabilities:
Accrued salaries and benefits.................................................... 15,061 12,694
Accrued miscellaneous taxes...................................................... 4,148 5,014
Accrued insurance................................................................ 762 215
Accrued interest................................................................. 3,833 3,902
Accrued management transition and consulting..................................... 1,787 1,092
Other............................................................................ 15,124 15,558
Income taxes payable.................................................................. 12,046 14,246
Deferred income taxes................................................................. 809 1,219
----------- -----------
Total current liabilities...................................................... 186,824 214,374
Long-term debt........................................................................ 211,427 221,026
Other non-current liabilities......................................................... 517 497
----------- -----------
Total liabilities.............................................................. 398,768 435,897
----------- -----------
Stockholders' equity
Common Stock, par value $.01 per share; authorized 25,000,000 shares; issued and
outstanding 7,558,838 and 9,779,050 shares, respectively......................... 76 98
Additional paid-in capital.......................................................... 47,725 86,135
Distributions to investor group in excess of carryover basis........................ (24,390) (24,390)
Note receivable from stock sale..................................................... (1,001) (1,001)
Retained earnings (deficit)......................................................... 3,145 18,340
Foreign currency translation adjustment............................................. (3,050) (6,843)
----------- -----------
Total stockholders' equity..................................................... 22,505 72,339
----------- -----------
Total liabilities and stockholders' equity..................................... $ 421,273 $ 508,236
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK DISTRIBUTIONS TO NOTE FOREIGN
----------------- ADDITIONAL INVESTOR GROUP RECEIVABLE RETAINED CURRENCY
NUMBER PAID-IN IN EXCESS OF FROM EARNINGS TRANSLATION
OF SHARES AMOUNT CAPITAL CARRYOVER BASIS STOCK SALE (DEFICIT) ADJUSTMENT
--------- ------ ---------- ---------------- ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 28, 1995........... 2,394,632 $ 24 $(19,237) $(24,390) $(1,001) $(12,146) $ (334)
Net income (loss)................. -- -- -- -- -- 14,251 --
Dividends on Series C Preferred
Stock........................... -- -- -- -- -- (717) --
Foreign currency translation
adjustment...................... -- -- -- -- -- -- (413)
Exercise of stock options......... 47,940 -- 444 -- -- -- --
Issuance of Common Stock.......... 2,500,000 25 30,133 -- -- -- --
Conversion of Series C Preferred
Stock to Common Stock........... 2,581,784 26 36,119 -- -- (10,000) --
--------- ------ ---------- ---------------- ----------- -------- ----------
Balance, February 3, 1996........... 7,524,356 75 47,459 (24,390) (1,001) (8,612) (747)
Net income (loss)................. -- -- -- -- -- 11,757 --
Foreign currency translation
adjustment...................... -- -- -- -- -- -- (2,303)
Exercise of stock options......... 34,482 1 266 -- -- -- --
--------- ------ ---------- ---------------- ----------- -------- ----------
Balance, February 1, 1997........... 7,558,838 76 47,725 (24,390) (1,001) 3,145 (3,050)
Net income (loss)................. -- -- -- -- -- 15,195 --
Foreign currency translation
adjustment...................... -- -- -- -- -- -- (3,793)
Issuance of Common Stock.......... 2,196,971 22 38,102 -- -- -- --
Exercise of stock options......... 23,241 -- 308 -- -- -- --
--------- ------ ---------- ---------------- ----------- -------- ----------
Balance, January 31, 1998........... 9,779,050 $ 98 $ 86,135 $(24,390) $(1,001) $ 18,340 $ (6,843)
--------- ------ ---------- ---------------- ----------- -------- ----------
--------- ------ ---------- ---------------- ----------- -------- ----------
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
-------------
<S> <C>
Balance, January 28, 1995........... $ (57,084)
Net income (loss)................. 14,251
Dividends on Series C Preferred
Stock........................... (717)
Foreign currency translation
adjustment...................... (413)
Exercise of stock options......... 444
Issuance of Common Stock.......... 30,158
Conversion of Series C Preferred
Stock to Common Stock........... 26,145
-------------
Balance, February 3, 1996........... 12,784
Net income (loss)................. 11,757
Foreign currency translation
adjustment...................... (2,303)
Exercise of stock options......... 267
-------------
Balance, February 1, 1997........... 22,505
Net income (loss)................. 15,195
Foreign currency translation
adjustment...................... (3,793)
Issuance of Common Stock.......... 38,124
Exercise of stock options......... 308
-------------
Balance, January 31, 1998........... $ 72,339
-------------
-------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)..................................................... $ 14,251 $ 11,757 $ 15,195
Adjustments to reconcile net income (loss) to net cash provided from
(used in) operating activities:
Depreciation and amortization......................................... 10,764 12,067 13,415
Imputed interest on debentures........................................ 7,697 8,494 9,545
Other, net............................................................ (1,534) (1,105) (1,817)
Changes in operating assets and liabilities, net of effects from
purchase of Diamond Park assets (Note 12):
(Increase) decrease in accounts and other receivables.............. (9,856) 1,548 (8,795)
Increase in merchandise inventories................................ (35,601) (28,380) (15,360)
(Increase) decrease in prepaid expenses and other.................. (267) 72 385
Increase in accounts payable and accrued liabilities............... 9,783 8,645 22,932
Increase (decrease) in deferred income taxes....................... (539) (27) 410
----------- ----------- -----------
Net cash provided from (used in) operating activities............ (5,302) 13,071 35,910
----------- ----------- -----------
Cash flows from investing activities:
Purchases of equipment, fixtures and leasehold improvements........... (14,933) (17,533) (19,338)
Payment for purchase of Diamond Park assets........................... -- -- (57,642)
Other, net............................................................ (1,582) (621) (1,935)
----------- ----------- -----------
Net cash used in investing activities............................ (16,515) (18,154) (78,915)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from revolving credit facility............................... 439,720 442,947 564,510
Principal payments on revolving credit facility....................... (439,720) (442,947) (564,510)
Repurchase of debentures.............................................. (5,789) -- --
Net proceeds from public offerings of common stock.................... 30,158 -- 38,124
Capitalized financing costs........................................... -- -- (2,347)
Other, net............................................................ 75 61 306
----------- ----------- -----------
Net cash provided from financing activities...................... 24,444 61 36,083
----------- ----------- -----------
Effect of exchange rate changes on cash.......................... (221) (146) (336)
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents................. 2,406 (5,168) (7,258)
Cash and cash equivalents, beginning of period.......................... 23,608 26,014 20,846
----------- ----------- -----------
Cash and cash equivalents, end of period................................ $ 26,014 $ 20,846 $ 13,588
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION OF THE COMPANY AND TRANSACTIONS
Finlay Enterprises, Inc., (the 'Company'), a Delaware corporation, conducts
business through its wholly owned subsidiary, Finlay Fine Jewelry Corporation
and its wholly owned subsidiaries ('Finlay Jewelry'). References to 'Finlay'
mean collectively, the Company and Finlay Jewelry. Finlay is a retailer of fine
jewelry products and primarily operates leased fine jewelry departments in
department stores throughout the United States and France. All references herein
to leased departments refer to departments operated pursuant to license
agreements or other arrangements with host department stores.
PUBLIC OFFERINGS AND RELATED TRANSACTIONS
On October 21, 1997, the Company completed a public offering (the '1997
Offering') of 3,450,000 shares of its common stock, par value $.01 per share
('Common Stock') at a price of $19.00 per share, of which 2,196,971 shares were
issued and sold by the Company. An additional 1,253,029 shares were sold by
existing stockholders. The underwriters' over-allotment was exercised in full.
Net proceeds to the Company from the 1997 Offering were $38,124,000. The Company
expects to use the funds resulting from the 1997 Offering for working capital,
repayment of indebtedness or other general corporate purposes.
On April 6, 1995, the Company completed an initial public offering (the
'Initial Public Offering') of 2,500,000 shares of its Common Stock, at a price
of $14.00 per share. An additional 115,000 shares were sold by non-management
selling stockholders. Net proceeds from the Initial Public Offering were
$30,200,000 and were used to repurchase $6,103,000 accreted balance of the
Company's 12% Senior Discount Debentures due 2005 (the 'Debentures') with the
balance of the net proceeds used to reduce a portion of the outstanding
indebtedness under Finlay's revolving credit facility with General Electric
Capital Corporation ('G.E. Capital') and the other lenders named thereto.
Immediately prior to the completion of the Initial Public Offering, the
holders of the Company's 10% Series C Cumulative Preferred Stock ('Series C
Preferred Stock') exchanged all outstanding shares of Series C Preferred Stock
with the Company for 2,581,784 shares of Common Stock (the 'Series C Exchange').
For purposes of the Series C Exchange, the outstanding Series C Preferred Stock
was (i) valued at its liquidation value of $30,000,000 plus $6,145,000 of
accrued dividends through the date of completion of the Series C Exchange, paid
in kind at a quarterly rate of 2.5%, and (ii) exchanged for Common Stock at the
initial public offering price of $14.00 per share.
THE 1993 RECAPITALIZATION
In May 1993, an affiliate of Thomas H. Lee Company (together with its
affiliated transferees, the 'Lee Investors') and partnerships managed by Desai
Capital Management Incorporated (collectively, the 'Desai Investors'), acquired
36.8% and 24.5%, respectively, of the outstanding voting securities of the
Company in a series of transactions which recapitalized the Company (the '1993
Recapitalization'). Following the 1993 Recapitalization, management maintained a
substantial equity interest in the Company.
The 1993 Recapitalization included an investment by the Lee Investors and
the Desai Investors in units consisting of the Series C Preferred Stock and
Common Stock (the 'Lee/Desai Units'). Concurrently, certain other existing
classes of preferred stock and all outstanding warrants to purchase Common Stock
were redeemed. These equity related transactions resulted in the Lee Investors
and the Desai Investors obtaining 52.6% beneficial ownership of the outstanding
Common Stock.
The 1993 Recapitalization also included the public issuance by the Company
of units consisting of Debentures and Common Stock, the public issuance by
Finlay Jewelry of the 10 5/8% Senior Notes due 2003 (the 'Notes') and the
refinancing of the Company's outstanding term loans and revolving indebtedness
with Westinghouse Credit Corporation ('WCC'). The WCC revolving credit facility
was replaced by the revolving credit facility with G.E. Capital. See Note 4.
F-7
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--ORGANIZATION OF THE COMPANY AND TRANSACTIONS (CONTINUED)
ORGANIZATION AND THE 1988 LEVERAGED RECAPITALIZATION
Finlay Jewelry was initially incorporated on August 2, 1985 as SL Holdings
Corporation ('SL Holdings'). The Company, incorporated on November 22, 1988, was
organized by certain officers and directors (the 'Investor Group') of SL
Holdings to acquire certain operations of SL Holdings. In connection with the
reorganization ('1988 Leveraged Recapitalization'), which resulted in the merger
of a wholly owned subsidiary of the Company into SL Holdings, SL Holdings
changed its name to Finlay Fine Jewelry Corporation and became a wholly owned
subsidiary of the Company.
The 1988 Leveraged Recapitalization was accounted for as a purchase in the
accompanying financial statements. Accordingly, the excess of the purchase price
over the net assets of Finlay Jewelry has been assigned to goodwill. Since
certain members of the Investor Group beneficially owned shares of SL Holdings
before the 1988 Leveraged Recapitalization and owned shares of the Company after
the 1988 Leveraged Recapitalization, the purchase method of accounting does not
apply to their ownership interest in SL Holdings. Accordingly, for accounting
purposes, stockholders' equity reflects the total shares of SL Holdings owned by
the Investor Group at their respective adjusted historical costs, reduced by the
consideration paid for the SL Holdings shares owned by the Investor Group. This
resulted in a reduction in stockholders' equity of $24,390,000 and is reflected
as Distributions to investor group in excess of carryover basis in the
accompanying Consolidated Balance Sheets.
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING AND PRESENTATION: The accompanying Consolidated
Financial Statements have been prepared on the accrual basis of accounting in
accordance with generally accepted accounting principles, which, for certain
financial statement accounts, requires the use of management's estimates. Actual
results may differ from these estimates.
FISCAL YEAR: The Company's fiscal year ends on the Saturday closest to
January 31. References to 1995, 1996 and 1997 relate to the fiscal years ended
on February 3, 1996, February 1, 1997 and January 31, 1998. Each of the fiscal
years includes 52 weeks except 1995, which includes 53 weeks.
MERCHANDISE INVENTORIES: Consolidated inventories are stated at the lower
of cost or market with cost for the domestic operations determined by the
last-in, first-out ('LIFO') method. Market represents estimated realizable value
after providing for a normal profit margin. The cost to Finlay of gold
merchandise sold on consignment, which typically varies with the price of gold,
is not fixed until the sale is reported to the vendor following the sale of the
merchandise. Finlay at times enters into futures contracts, such as options or
forwards, based upon the anticipated sales of gold product in order to hedge
against the risk arising from those payment arrangements. Changes in the market
value of futures contracts are accounted for as an addition to or reduction from
the inventory cost. For the years ended February 3, 1996, February 1, 1997 and
January 31, 1998, the gain/loss on open futures contracts was not material. The
Company did not have any open positions in futures contracts for gold at
February 1, 1997 or January 31, 1998.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization, except where
otherwise indicated, are computed by the straight-line method over the estimated
useful lives of the fixed assets ranging from three to thirty-nine years. In
1997, the Company capitalized $660,000 of interest in connection with the
construction of its warehouse and distribution facility. The capitalized
interest was recorded as part of the asset to which it related and is being
amortized over the asset's estimated useful life.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiary, Finlay Jewelry. All
significant intercompany transactions have been eliminated in consolidation.
F-8
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SOFTWARE DEVELOPMENT COSTS: Costs incurred for the routine operation and
maintenance of management information systems are expensed as incurred. It is
the Company's policy to capitalize significant amounts relating to software
purchased from third party software vendors as well as external consulting costs
incurred in the development and improvement of management information systems.
In 1998, Statement of Position No. 98-1, 'Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use' was issued, whereby
the Company will be required to capitalize certain internal payroll costs for
employees directly associated with the development of software for internal use.
The Company intends to adopt this statement in 1999, and does not expect it to
have a material impact on its consolidated financial statements.
INTANGIBLE ASSETS ARISING FROM ACQUISITION: The excess purchase price paid
over the fair market value of net assets acquired ('Goodwill') was recorded in
accordance with Accounting Principles Board ('APB') Opinion No. 16--'Accounting
for Business Combinations' and is being amortized on a straight-line basis. The
Goodwill related to the 1988 Leveraged Recapitalization and the Diamond Park
Acquisition (as defined in Note 12) is being amortized over 40 years and 20
years, respectively. The Company continually evaluates the carrying value and
the economic useful life of Goodwill based on the Company's operating results
and the expected future net cash flows and will adjust the carrying value and
the related amortization periods, if and when appropriate. Amortization of
Goodwill for 1995, 1996 and 1997 totaled $3,149,000, $3,143,000 and $3,367,000,
respectively. Accumulated amortization of Goodwill at February 1, 1997 and
January 31, 1998 totaled $24,551,000 and $27,825,000, respectively.
FOREIGN CURRENCY TRANSLATION: Results of operations for Finlay Jewelry's
foreign subsidiary are translated into U.S. dollars using the average exchange
rates during the period, while assets and liabilities are translated using
current rates in accordance with Statement of Financial Accounting Standards
('SFAS') No. 52, 'Foreign Currency Translation'. The resulting translation
adjustments are recorded directly into a separate component of Stockholders'
equity. Transaction gains and losses are reported in net income and were not
significant in any year.
NET INCOME (LOSS) PER SHARE: Net income (loss) per share has been computed
in accordance with SFAS No. 128, 'Earnings per Share' which was adopted by the
Company at the end of 1997. Basic and diluted net income (loss) per share were
calculated using the weighted average number of shares outstanding during each
period, with options to purchase Common Stock included in diluted net income
(loss) per share, using the treasury stock method, to the extent that such
options were dilutive. The per share amounts for each period presented have been
restated to reflect the adoption of SFAS No. 128. The following is an analysis
of the differences between basic and diluted net income (loss) per share:
<TABLE>
<CAPTION>
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
-------------------------- -------------------------- --------------------------
NO. OF PER NO. OF PER NO. OF PER
SHARES SHARE SHARES SHARE SHARES SHARE
------------- --------- ------------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Weighted average shares
outstanding................ 6,458,563 $0.55 7,417,343 $1.59 8,050,346 $1.89
Dilutive stock options....... 181,164 (0.02) 152,186 (0.04) 225,588 (0.05)
------------- --------- ------------- --------- ------------- ---------
Weighted average shares and
share equivalents.......... 6,639,727 $0.53 7,569,529 $1.55 8,275,934 $1.84
------------- --------- ------------- --------- ------------- ---------
------------- --------- ------------- --------- ------------- ---------
</TABLE>
For each of 1995, 1996 and 1997, there were no adjustments to Net income
(loss) applicable to common shares used to calculate basic and diluted net
income (loss) per share.
F-9
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME (LOSS) APPLICABLE TO COMMON SHARES: The Company has reflected
in Net income (loss) applicable to common shares, dividends and accretion on the
conversion of Preferred Stock for each period presented, as appropriate.
DEBT ISSUANCE COSTS: Debt issuance costs of $10,876,000 arising primarily
from the 1993 Recapitalization are being amortized using the straight line
method over the terms of the related debt agreements. These debt issuance costs
totaled approximately $4,600,000 at February 1, 1997 and $5,862,000 at January
31, 1998. The debt issuance costs are reflected as a component of Deferred
charges and other assets in the accompanying Consolidated Balance Sheets.
Amortization of debt issuance costs for 1995, 1996 and 1997 totaled $1,037,000,
$1,056,000 and $1,055,000, respectively, and have been recorded as a component
of Interest expense, net in the accompanying Consolidated Statements of
Operations.
COST OF SALES: Cost of sales includes the cost of merchandise sold, repair
expense, shipping, shrinkage and inventory losses. Buying and occupancy costs
such as lease and rental fees are not included in Cost of sales and are
reflected in Selling, general and administrative expenses in the accompanying
Consolidated Statements of Operations.
ADVERTISING COSTS: All costs associated with advertising are expensed in
the month that the advertising takes place. For 1995, 1996 and 1997, gross
advertising expenses were $39,862,000, $43,747,000 and $47,913,000 and are
included in Selling, general and administrative expenses in the accompanying
Consolidated Statements of Operations.
STATEMENTS OF CASH FLOWS: The Company considers cash on hand, deposits in
banks and deposits in money market funds as cash and cash equivalents. Interest
paid during 1995, 1996 and 1997 was $21,027,000, $21,480,000 and $23,347,000
(net of capitalized interest), respectively. Income taxes paid in 1995, 1996 and
1997 totaled $9,372,000, $9,368,000 and $10,676,000, respectively. Refer to Note
12 for a discussion of the Diamond Park Acquisition.
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 because of the short-term
maturity of these instruments. Marketable securities are recorded in the
consolidated financial statements at current market values, which approximates
cost. The fair values of the Company's debt and off-balance sheet financial
instruments are disclosed in Note 4.
STOCK-BASED COMPENSATION: Stock-based compensation is recognized using the
intrinsic value method. For disclosure purposes, pro forma net income and
earnings per share are provided as if the fair value method had been applied.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS: SFAS No. 121,
'Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of', requires long-lived assets as well as identifiable intangibles
be reviewed for impairment whenever events or changes in circumstances indicate
the carrying amount of the assets may not be recoverable. Upon adoption of this
Statement in 1996 and to date, there was no impact on the Company's financial
position or results of operations.
SEASONALITY: A significant portion of Finlay's revenues are generated in
the fourth quarter due to the seasonality of the retail industry. As such,
results for interim periods are not indicative of annual results. Refer to Note
11 for unaudited quarterly financial data.
F-10
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--MERCHANDISE INVENTORIES
Merchandise inventories consisted of the following:
<TABLE>
<CAPTION>
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------------
(IN THOUSANDS)
<S> <C> <C>
Jewelry goods--rings, watches and other fine jewelry
(specific identification basis)............................ $ 231,298 $ 286,289
Excess of specific identification cost over LIFO inventory
value...................................................... 8,853 6,523
----------- -----------------
$ 222,445 $ 279,766
----------- -----------------
----------- -----------------
</TABLE>
The LIFO method had the effect of decreasing Income (loss) before income
taxes in 1995 and 1996 by $943,000 and $1,919,000, respectively, and increasing
Income (loss) before income taxes in 1997 by $2,330,000. Finlay determines its
LIFO inventory value by utilizing selected producer price indices published for
jewelry and watches by the Bureau of Labor Statistics. Due to the application of
APB Opinion No. 16, inventory valued at LIFO for income tax reporting purposes
is approximately $21,000,000 lower than that for financial reporting purposes at
January 31, 1998.
Approximately $194,276,000 and $219,822,000 at February 1, 1997 and January
31, 1998, respectively, of merchandise received on consignment has been excluded
from Merchandise inventories and Accounts payable-trade in the accompanying
Consolidated Balance Sheets.
In August 1995, Finlay Jewelry entered into a gold consignment agreement
(the 'Gold Consignment Agreement') with Rhode Island Hospital Trust National
Bank ('RIHT'), which matures on May 31, 1998. The Gold Consignment Agreement
enables Finlay Jewelry to receive merchandise by providing gold, or otherwise
making payment, to certain vendors who currently supply Finlay with merchandise
on consignment. While the merchandise involved remains consigned, title to the
gold content of the merchandise transfers from the vendors to RIHT. As a result,
such vendors have reduced their working capital requirements and associated
financing costs. Consequently, Finlay has negotiated more favorable prices and
terms with the participating vendors.
Finlay can obtain, pursuant to the Gold Consignment Agreement, up to the
lesser of (i) 85,000 fine troy ounces or (ii) $25 million worth of gold, subject
to a formula as prescribed by the Gold Consignment Agreement. At February 1,
1997 and January 31, 1998, amounts outstanding under the Gold Consignment
Agreement totaled 36,916 and 39,676 fine troy ounces, respectively, valued at
approximately $12.8 million and $12.1 million, respectively. The purchase price
per ounce is based on the daily Second London Gold Fixing. For financial
statement purposes, the consigned gold is not included in Merchandise
inventories on the Company's Consolidated Balance Sheets and, therefore, no
related liability has been recorded. Under the Gold Consignment Agreement,
Finlay is required to pay a daily consignment fee on the dollar equivalent of
the fine gold value of the ounces of gold consigned thereunder. The daily
consignment fee is based on a floating rate which, as of February 1, 1997 and
January 31, 1998, was approximately 4.5% and 4.3%, respectively, per annum. In
addition, Finlay is required to pay an unused line fee of 0.5% if the amount of
gold consigned has a value equal to or less than $10 million. Included in
interest expense for the year ended February 1, 1997 and January 31, 1998 are
consignment fees of $638,000 and $725,000, respectively.
In conjunction with the Gold Consignment Agreement, Finlay Jewelry granted
RIHT a first priority perfected lien on, and a security interest in, specified
gold jewelry of participating vendors approved under the Gold Consignment
Agreement and a lien on proceeds and products of such jewelry subject to the
terms of an intercreditor agreement between RIHT and G.E. Capital.
The Gold Consignment Agreement requires Finlay Jewelry to comply with
certain covenants, including restrictions on the incurrence of certain
indebtedness, the incurrence or creation of liens, engaging in certain
transactions with affiliates and related parties and limitations on the payment
of dividends. The Gold Consignment Agreement also contains various financial
covenants, including fixed charge coverage ratio requirements and certain
maximum debt limitations. Finlay Jewelry was in compliance with all of its
financial covenants as of and for the year ended January 31, 1998.
F-11
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--SHORT AND LONG-TERM DEBT
The Company and Finlay Jewelry are parties to a credit agreement with G.E.
Capital and the other lenders thereto (the 'Revolving Credit Agreement') which
provides Finlay with a senior secured revolving line of credit of up to $225
million (the 'Revolving Credit Facility'), a portion of which is available to
the Company under certain circumstances. The Revolving Credit Facility provides
Finlay with a facility maturing in March 2003, for borrowings based on an
advance rate of (i) up to 85% of eligible accounts receivable and (ii) up to 60%
of eligible owned inventory after taking into account such reserves or offsets
as G.E. Capital may deem appropriate (the 'Borrowing Base'). Eligibility
criteria are established by G.E. Capital, which retains the right to adjust the
Borrowing Base in its reasonable judgement by revising standards of eligibility,
establishing reserves and/or increasing or decreasing from time to time the
advance rates (except that any increase in the borrowing base rate percentage
shall require the consent of the lenders). Finlay Jewelry is permitted to use up
to $30 million of the Revolving Credit Agreement for the guarantee of letters of
credit issued for the account of Finlay Jewelry. The outstanding revolving
credit balance and letter of credit balance under the Revolving Credit Agreement
are required to be reduced each year to $50 million or less and $20 million or
less, respectively, for a 30 consecutive day period (the 'Balance Reduction
Requirement'). However, the indentures with respect to the Notes (the 'Note
Indenture') and Debentures (the 'Debenture Indenture') require Finlay to reduce
the balance of the Revolving Credit Agreement in each year to $10 million or
less for a specified 25 consecutive day period. Funds available under the
Revolving Credit Agreement are utilized for working capital purposes.
Amounts outstanding under the Revolving Credit Agreement presently bear
interest at a rate equal to, at Finlay's option, (i) the Index Rate (as defined)
plus 0.5% or (ii) for one or more portions of the Revolving Credit Facility of
$1.0 million or any greater integral multiple thereof, reserve adjusted LIBOR
plus 1.5%. Commencing in late 1998, amounts outstanding under the Revolving
Credit Agreement will bear interest at a rate equal to, at Finlay's option, (i)
the Index Rate plus a margin ranging from zero to 1.0% or (ii) adjusted LIBOR
plus a margin ranging from 1.0% to 2.0%, in each case depending on the financial
performance of the Company. 'Index Rate' is defined as the higher of (i) the
rate publicly quoted from time to time by The Wall Street Journal as the 'base
rate on corporate loans at large U.S. money center commercial banks' and (ii)
the Federal Funds Rate plus 50 basis points per annum. A letter of credit fee of
1.5% per annum of the face amount of letters of credit guaranteed under the
Revolving Credit Agreement and an unused facility fee equal to 0.375% per annum
on the average unused daily balance of the Revolving Credit Facility is payable
monthly in arrears. Upon the occurrence (and during the continuance) of an event
of default under the Revolving Credit Agreement, interest would accrue at a rate
which is 2% in excess of the rate otherwise applicable, and would be payable
upon demand.
The Revolving Credit Agreement is secured by a first priority perfected
security interest in all of Finlay Jewelry's (and any subsidiary's) present and
future tangible and intangible assets, excluding any of the Company's lease
agreements which are not assignable without the lessor's consent.
The Revolving Credit Agreement contains customary covenants, including
limitations on capital expenditures, limitations on borrowing transactions
between Finlay and its officers, directors, employees and affiliates and
limitations on payments of dividends. In addition, the lenders have the right to
approve certain private sales of Common Stock. The Revolving Credit Agreement
also contains various financial covenants, including minimum earnings and fixed
charge coverage ratio requirements and certain maximum debt limitations. Finlay
was in compliance with all of its financial covenants as of and for the year
ended January 31, 1998.
There were no amounts outstanding at February 1, 1997 or January 31, 1998
under the Revolving Credit Agreement. The maximum amounts outstanding under the
Revolving Credit Agreement during
F-12
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--SHORT AND LONG-TERM DEBT (CONTINUED)
1995, 1996 and 1997 were $99,100,000, $114,100,000 and $189,200,000,
respectively. The average amounts outstanding for the same periods were
$68,400,000, $75,371,000 and $107,700,000, respectively. The weighted average
interest rates during the period were 8.9%, 8.0% and 7.9% for 1995, 1996 and
1997, respectively.
At February 1, 1997 and January 31, 1998, Finlay had letters of credit
outstanding totaling $11.1 million and $10.3 million, respectively, which
guarantee various trade activities. The contract amount of the letters of credit
approximate their fair value.
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Senior Notes (a).................................................. $ 135,000 $ 135,000
Debentures (b).................................................... 76,427 86,026
Other............................................................. 2 --
----------- -----------
211,429 221,026
Less--current portion............................................. 2 --
----------- -----------
$ 211,427 $ 221,026
----------- -----------
----------- -----------
</TABLE>
- ------------------
(a) On May 26, 1993, as part of the 1993 Recapitalization, Finlay Jewelry issued
10 5/8% Senior Notes due 2003 with an aggregate principal amount of
$135,000,000. Interest on the Notes is payable semi-annually on May 1 and
November 1 of each year, and commenced on November 1, 1993. Except in the
case of certain equity offerings, the Notes are not redeemable prior to May
1, 1998. Thereafter, the Notes will be redeemable, in whole or in part, at
the option of Finlay, at specified redemption prices plus accrued and unpaid
interest, if any, to the date of the redemption. In the event of a Change of
Control (as defined in the Note Indenture), each holder of the Notes will
have the right to require Finlay Jewelry to repurchase its Notes at a
purchase price equal to 101% of the principal amount thereof plus accrued
and unpaid interest thereon to the repurchase date. The Notes rank senior in
right of payment to all subordinated indebtedness of Finlay and pari passu
in right of payment with all senior borrowings, including borrowings under
the Revolving Credit Agreement. However, because the Revolving Credit
Agreement is secured by a pledge of substantially all the assets of Finlay
Jewelry, the Notes are structurally subordinated to the borrowings under the
Revolving Credit Agreement. The Note Indenture contains restrictions
relating to, among other things, the payment of dividends, the repurchase of
stock and the making of certain other restricted payments, the incurrence of
additional indebtedness, the creation of certain liens, certain asset sales
transactions with subsidiaries and other affiliates and mergers and
consolidations.
The fair value of the Notes at January 31, 1998, determined based on market
quotes, was $141,750,000.
(b) On May 26, 1993, as part of the 1993 Recapitalization, the Company sold, for
$55,167,140, an aggregate of 98,000 units consisting of $98,000,000 12%
Senior Discount Debentures due 2005 and 130,667 shares of Common Stock.
Based on a fair market value of $7.23 per share on May 26, 1993, $944,067
was allocated to Common Stock with a resulting discount to the Debentures.
Commencing May 1, 1998, interest will accrue until maturity. Interest on the
Debentures is payable semi-annually on May 1 and November 1 of each year,
commencing November 1, 1998. Except in the case of certain equity offerings,
the Debentures are not redeemable prior to May 1, 1998. In the
F-13
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--SHORT AND LONG-TERM DEBT (CONTINUED)
event of a Change of Control (as defined in the Debenture Indenture), each
holder of the Debentures will have the right to require the Company to
repurchase its Debentures at a purchase price equal to 101% of the
principal amount thereof plus accrued and unpaid interest thereon to the
repurchase date. Thereafter, the Debentures will be redeemable, in whole
or in part, at the option of the Company, at specified redemption prices
plus accrued and unpaid interest, if any, to the date of redemption.
The Debentures rank pari passu in right of payment to all senior
indebtedness of the Company and senior in right of payment to all
subordinated indebtedness of the Company. The Debentures are secured by a
first priority lien on and security interest in all of the issued and
outstanding stock and intercompany indebtedness, if any, of Finlay Jewelry.
However, the operations of the Company are conducted through Finlay Jewelry
and, therefore, the Company is dependent upon the cash flow of Finlay
Jewelry to meet its obligations, including its obligations under the
Debentures. As a result, the Debentures are effectively subordinated to all
indebtedness and all other obligations of Finlay Jewelry. The Debenture
Indenture contains restrictions relating to, among other things, the payment
of dividends, the repurchase of stock and the making of certain other
restricted payments, the incurrence of additional indebtedness, the creation
of certain liens, certain asset sales transactions with subsidiaries and
other affiliates and mergers and consolidations. The amount of imputed
interest recorded in 1995, 1996 and 1997 was $7,697,000, $8,494,000 and
$9,545,000, respectively.
The fair value of the Debentures, determined based on market quotes, was
$87,061,000 at January 31, 1998.
Finlay was in compliance with all of the provisions of the Note and
Debenture Indentures as of and for the year ended January 31, 1998.
The aggregate amounts of long-term debt payable in each of the five years
in the period ending February 1, 2003 and thereafter are as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
1998...................................................... $ --
1999...................................................... --
2000...................................................... --
2001...................................................... --
2002...................................................... --
Thereafter................................................ 221,026
--------------
$221,026
--------------
--------------
</TABLE>
Interest expense for 1995, 1996 and 1997 was $29,859,000, $31,301,000 and
$34,213,000, respectively. Interest income for the same periods was $154,000,
$97,000 and $98,000, respectively.
NOTE 5--SERIES C PREFERRED STOCK
Concurrently with the consummation of the 1993 Recapitalization, the
Company and Finlay Jewelry entered into a stock purchase agreement (the '1993
Stock Purchase Agreement') with the Lee/Desai Investors, pursuant to which the
Lee/Desai Investors purchased from the Company the Lee/Desai Units consisting of
an aggregate of 1,384,259 shares of Common Stock of the Company and 300,000
shares of Series C Preferred Stock. The Common Stock issued to the Lee/Desai
Investors as part of the Lee/Desai Units constituted 52.6% of the outstanding
Common Stock of the Company on a fully diluted basis. The aggregate purchase
price for the Lee/Desai Units, paid to the Company at the closing, was
F-14
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--SERIES C PREFERRED STOCK (CONTINUED)
$30 million, of which $10 million was allocated to the Common Stock of the
Company and $20 million was allocated to the Series C Preferred Stock.
Immediately prior to the Initial Public Offering, as a result of the Series C
Exchange, the holders of the Series C Preferred Stock exchanged all outstanding
shares of Series C Preferred Stock for shares of Common Stock. In conjunction
with the Series C Exchange, a $10,000,000 nonrecurring noncash charge
representing the difference between the liquidation value and the carrying
value of the Series C Preferred Stock was recorded, decreasing Net income
(loss) applicable to common shares in 1995. See Note 1. Dividends accrued
in 1995 totaled $717,000.
NOTE 6--STOCKHOLDERS' EQUITY
The Company's Long Term Incentive Plan (the '1993 Plan') permits the
Company to grant to key employees of the Company and its subsidiaries,
consultants and certain other persons, and directors of the Company (other than
members of the Compensation Committee of the Company's Board of Directors), the
following: (i) stock options; (ii) stock appreciation rights in tandem with
stock options; (iii) limited stock appreciation rights in tandem with stock
options; (iv) restricted or nonrestricted stock awards subject to such terms and
conditions as the Compensation Committee shall determine; (v) performance units
which are based upon attainment of performance goals during a period of not less
than two nor more than five years and which may be settled in cash or in Common
Stock at the discretion of the Compensation Committee; or (vi) any combination
of the foregoing. Under the 1993 Plan, the Company may grant stock options which
are either incentive stock options within the meaning of Section 422 of the
Internal Revenue Code of 1986, as amended (the 'Code'), or non-incentive stock
options. As of January 31, 1998, an aggregate of 732,596 shares of the Company's
Common Stock has been reserved for issuance pursuant to the 1993 Plan, of which
a total of 640,052 shares are subject to options granted to certain senior
management, key employees and a director.
On March 6, 1997, the Board of Directors of the Company adopted the 1997
Long Term Incentive Plan (the '1997 Plan'), which was approved by the Company's
stockholders in June 1997. The 1997 Plan, which is similar to the 1993 Plan, is
intended as a successor to the 1993 Plan and provides for the grant of the same
types of awards as are currently available under the 1993 Plan. An aggregate of
350,000 shares of the Company's Common Stock have been reserved for issuance
pursuant to the 1997 Plan, of which a total of 349,448 shares are subject to
options granted to certain senior management, key employees and a director. The
exercise prices of such options range from $13.875 per share to $23.188 per
share.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
'Accounting for Stock-Based Compensation,' which became effective in 1996. As
permitted by SFAS No. 123, the Company has elected to continue to account for
stock-based compensation using the intrinsic value method. Accordingly, no
compensation expense has been recognized for its stock-based compensation plans.
Had the fair value method of accounting been applied to the Company's stock
option plans, which requires recognition of compensation cost ratably over the
vesting period of the stock options, net income would have been reduced by
$228,000, or $0.03 per share (for each of basic and diluted), in 1995, $219,000,
or $0.03 per share (for each of basic and diluted), in 1996 and $330,000, or
$0.04 per share (for each of basic and diluted), in 1997. This pro forma impact
only reflects options granted since the beginning of 1995 and therefore the
resulting compensation cost may not be representative of that to be expected in
future years.
The fair value of options granted in 1995, 1996 and 1997 was estimated
using the Black-Scholes option-pricing model based on the weighted average
market price at the grant date of $13.67 in 1995, $13.56 in 1996 and $14.95 in
1997 and the following weighted average assumptions: risk free interest
F-15
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--STOCKHOLDERS' EQUITY (CONTINUED)
rate of 6.89%, 6.67% and 6.57% for 1995, 1996 and 1997, respectively, expected
life of seven years for each of 1995, 1996 and 1997 and volatility of 35.10%
for 1995 and 1996 and 32.98% for 1997. The weighted average fair value of
options granted in 1995, 1996 and 1997 was $7.02, $6.88 and $7.33, respectively.
The following summarizes the transactions pursuant to the Company's 1993
Plan and 1997 Plan for 1995, 1996 and 1997:
<TABLE>
<CAPTION>
1995 1996 1997
---------------------- ---------------------- ----------------------
NUMBER OF WTD. AVG. NUMBER OF WTD. AVG. NUMBER OF WTD. AVG.
OPTIONS EX. PRICE OPTIONS EX. PRICE OPTIONS EX. PRICE
--------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year......... 396,821 $ 9.11 545,834 $11.61 523,767 $11.93
Granted.................................. 264,505 13.67 21,333 13.56 505,167 14.95
Exercised................................ (41,284) 7.23 (27,826) 7.23 (23,241) 8.74
Forfeited................................ (74,208) 8.00 (15,574) 11.45 (16,193) 11.25
--------- ---------- --------- ---------- --------- ----------
Outstanding at end of year............... 545,834 11.61 523,767 11.93 989,500 13.55
--------- ---------- --------- ---------- --------- ----------
--------- ---------- --------- ---------- --------- ----------
Exercisable at end of year............... 113,970 $ 9.73 207,122 $10.94 282,020 $11.47
</TABLE>
The options outstanding at January 31, 1998 have exercise prices between
$7.23 and $23.19, with a weighted average exercise price of $13.55 and a
weighted average remaining contractual life of 7.88 years. Options generally
vest in five years and expire in ten years from their dates of grant.
Upon the commencement of his employment, a senior officer of the Company
purchased 138,525 shares of Common Stock (the 'Purchased Shares'), at a price of
$7.23 per share. The aggregate purchase price of these shares was paid in the
form of a note issued to the Company in the amount of $1,001,538. The note is
secured by the Purchased Shares and certain proceeds from the sale of the
Purchased Shares or any distribution paid on or with respect to the Purchased
Shares. Interest accrues on the unpaid balance of the note at a rate equal to
7.92% per annum, compounded annually. In the event of termination of employment,
the Purchased Shares (together with vested options and shares issued upon
exercise of vested options ('Option Shares')) are subject to certain call rights
and the Option Shares are additionally subject to certain put rights. In the
event the Company does not exercise its call rights, the rights may be exercised
by the Lee Investors and the Desai Investors, pro rata based on their respective
ownership of Common Stock. The Purchased Shares and Option Shares are subject to
certain restrictions on transfer. As a result of the terms of the note, the
amount of the note is reflected as a reduction to equity and is reflected in the
Company's Consolidated Balance Sheets as Note receivable from stock sale.
In connection with and prior to the Initial Public Offering and the related
transactions, the Board of Directors and the shareholders of the Company
approved a change in the Company's capital stock to authorize 25,000,000 shares
of Common Stock, par value $.01 per share. On March 7, 1995, the Company
effected a two-for-three stock combination of its issued and outstanding Common
Stock.
NOTE 7--LEASE AGREEMENTS
Finlay conducts substantially all of its operations as leased departments
in department stores. All of these leases, as well as rentals for office space
and equipment, are accounted for as operating leases. A substantial number of
such operating leases expire on various dates through 2008.
Substantially all of the department store leases provide that the title to
certain fixed assets of Finlay transfers upon termination of the leases, and
that Finlay will receive the undepreciated value of such fixed assets from the
host store in the event such transfers occur. The values of such fixed assets
are
F-16
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--LEASE AGREEMENTS (CONTINUED)
recorded at the inception of the lease arrangement and are reflected in the
accompanying Consolidated Balance Sheets.
In many cases, Finlay is subject to limitations under its lease agreements
with host department stores which prohibit Finlay from operating departments for
other store groups within a certain geographical radius of the host store.
The store leases provide for the payment of fees based on sales, plus, in
some instances, installment payments for fixed assets. Lease expense, included
in Selling, general and administrative expenses, is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Minimum fees........................................ $ 10,555 $ 6,188 $ 9,732
Contingent fees..................................... 94,679 103,319 115,331
----------- ----------- -----------
Total.......................................... $ 105,234 $ 109,507 $ 125,063
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
Future minimum payments under noncancellable operating leases having
initial or remaining noncancellable lease terms in excess of one year are as
follows as of January 31, 1998:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
1998...................................................... $ 24,824
1999...................................................... 19,830
2000...................................................... 12,552
2001...................................................... 6,231
2002...................................................... 2,086
Thereafter................................................ 11,001
--------------
Total minimum payments required...................... $ 76,524
--------------
--------------
</TABLE>
Minimum payments shown above have not been reduced by minimum sublease
payments of approximately $125,000 due in the future under noncancellable
subleases.
NOTE 8--PENSION PLANS
Finlay maintains a defined contribution profit-sharing plan to provide
retirement benefits for all personnel. This plan provides for company matching
contributions of $.25 for each $1.00 of employee contribution, up to 5% of the
employee's salary, as limited by the Code. Additionally, Finlay contributes 2%
of the employees' earnings annually, as limited by the Code. Vesting in Finlay's
contributions begins upon completion of three years of employment and accrues at
the rate of 20% per year.
Finlay also provides fixed retirement benefits for certain former employees
not covered by existing pension plans. The estimated liability for such benefits
has been accrued for in these financial statements and is reflected as
components of Other accrued liabilities and Other non-current liabilities.
The cost of the defined contribution plan maintained by Finlay and the
retirement benefits for certain former employees aggregated $1,728,000,
$1,753,000 and $1,771,000 for 1995, 1996 and 1997, respectively.
F-17
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--INCOME TAXES
For income tax reporting purposes, the Company has an October 31 year end.
The Company files a consolidated Federal income tax return with its wholly owned
subsidiary, Finlay Jewelry and its wholly owned subsidiaries.
Deferred income taxes at year end reflect the impact of temporary
differences between amounts of assets and liabilities for financial and tax
reporting purposes.
Deferred tax assets and liabilities at year end are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
--------------------------
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Deferred Tax Assets
Uniform inventory capitalization.................................................... $ 3,462 $ 3,569
Expenses not currently deductible................................................... 4,074 3,493
ITC carryover....................................................................... 1,100 950
AMT credit.......................................................................... 566 566
Deferred financing costs-current.................................................... 203 --
----------- -----------
9,405 8,578
Valuation allowance................................................................. 1,200 1,050
----------- -----------
Total current.................................................................. 8,205 7,528
----------- -----------
Imputed interest on Debentures...................................................... 9,407 12,747
Deferred financing costs-non-current................................................ 371 207
----------- -----------
Total non-current.............................................................. 9,778 12,954
----------- -----------
Total deferred tax assets................................................... 17,983 20,482
----------- -----------
Deferred Tax Liabilities
LIFO inventory valuation............................................................ 9,014 8,747
----------- -----------
Total current.................................................................. 9,014 8,747
----------- -----------
Depreciation........................................................................ 7,029 8,295
----------- -----------
Total non-current.............................................................. 7,029 8,295
----------- -----------
Total deferred tax liabilities.............................................. 16,043 17,042
----------- -----------
Net deferred income tax assets............................................ $ 1,940 $ 3,440
----------- -----------
----------- -----------
Net current deferred income tax liabilities.................................... $ (809) $(1,219)
Net non-current deferred income tax assets..................................... 2,749 4,659
----------- -----------
Net deferred income tax assets............................................ $ 1,940 $ 3,440
----------- -----------
----------- -----------
</TABLE>
The components of income tax expense are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
--------------------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Current domestic taxes................................................ $ 10,174 $ 11,777 $ 13,427
Current foreign taxes................................................. 1,238 1,045 600
Deferred taxes........................................................ (2,069) (1,787) (1,500)
-------------- -------------- --------------
Income tax expense.................................................... $ 9,343 $ 11,035 $ 12,527
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
F-18
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--INCOME TAXES (CONTINUED)
A reconciliation of the income tax provision computed by applying the
federal statutory rate to Income (loss) before income taxes to the Provision for
income taxes on the accompanying Consolidated Statements of Operations is as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
--------------------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Federal Statutory Provision........................................... $ 8,258 $ 7,977 $ 9,703
Foreign taxes......................................................... 1,238 1,045 600
State tax, net of federal benefit..................................... 1,688 1,857 1,642
Non-deductible amortization........................................... 1,037 1,037 1,037
Life insurance proceeds............................................... (1,750) -- --
Benefit of foreign tax credit......................................... (1,238) (1,045) (600)
Other 110 164 145
-------------- -------------- --------------
Provision for income taxes............................................ $ 9,343 $ 11,035 $ 12,527
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
Section 382 of the Code restricts utilization of net operating loss
carryforwards ('NOLs') after an ownership change exceeding 50%. As a result of
the 1993 Recapitalization, a change in ownership of the Company exceeding 50%
occurred within the meaning of Section 382 of the Code (a 'Change of Control').
Similar restrictions will apply to other carryforwards. Consequently, there is a
material limitation on the annual utilization of the Company's net operating
loss and other carryforwards which requires a deferral or loss of the
utilization of such carryforwards. At October 31, 1997, the Company has a NOL
carryforward for tax purposes of $12,000,000 which is subject to an annual limit
of approximately $2,000,000 per year, of which $8,000,000 expires in 2004 and
$4,000,000 expires in 2005. At October 31, 1997, the Company had investment tax
credit ('ITC') carryovers of approximately $950,000, of which $649,000 expires
in 1998, $264,000 in 1999 and $37,000 in 2000. At October 31, 1997, the Company
also had Alternative Minimum Tax Credit ('AMT') carryovers of $566,000 which may
be used indefinitely to reduce federal income taxes. An additional change in
ownership within the meaning of Section 382 of the Code has occurred as a result
of the 1997 Offering. However, there are no additional restrictions upon the
Company's ability to utilize its NOLs or other carryforwards as a result of such
ownership change.
SFAS No. 109 'Accounting for Income Taxes,' requires that the tax benefit
of such NOLs and tax credits be recorded as an asset to the extent that
management assesses the utilization to be 'more likely than not'. As the
accompanying Consolidated Financial Statements include profits earned after the
tax year end at October 31, (the profit of the year-end holiday season), for
financial reporting purposes only, the NOL carryforward has been absorbed in
full and no NOL carryfoward exists as of January 31, 1998. Management determined
at January 31, 1998, that based upon the Company's history of operating earnings
and its expectations for the future, no change to the valuation allowance is
warranted, with the exception of amounts utilized to offset the expiration
during 1997 of an ITC carryover.
NOTE 10--COMMITMENTS AND CONTINGENCIES
The Company, from time to time, is involved in litigation concerning its
business affairs. Management believes that the resolution of all pending
litigation will not have a material adverse effect on the consolidated financial
statements.
The Company has employment agreements with two senior members of management
which provide for minimum salary levels as well as incentive compensation based
on meeting specific financial goals. Such agreements have remaining terms of one
and three years. In addition, the Company has an agreement with a senior member
of management which provides for one year's salary if employment is terminated
without cause. Such agreements have a remaining aggregate minimum value of
approximately $3.9 million as of January 31, 1998.
F-19
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Revolving Credit Agreement, the Gold Consignment Agreement and the Note
Indenture currently restrict annual distributions from Finlay Jewelry to the
Company to 0.25% of Finlay Jewelry's net sales for the preceding fiscal year.
During 1997, dividends of $1,712,000 were declared. During 1996, dividends of
$1,636,000 were declared and $818,000 was distributed to the Company. During
1995, dividends of $1,380,000 were declared and $1,810,000 was distributed to
the Company.
The Company's concentration of credit risk consists principally of accounts
receivable. Approximately 71%, 75% and 72% of Finlay's domestic sales in 1995,
1996 and 1997, respectively, were from operations in two major department store
groups of which 48%, 51% and 49% represents Finlay's domestic sales from one
department store group in the respective years. The Company believes that the
risk associated with these receivables, other than those from department store
groups indicated above, would not have a material adverse effect on the
Company's financial position or results of operations.
Liberty House, one of the host stores in which Finlay operates, has
requested deferral of approximately $2.0 million of 1997 sales due to the
Company. The Company is currently receiving weekly payments against the
outstanding balance.
NOTE 11--QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table summarizes the quarterly financial data for 1995, 1996
and 1997 (dollars in thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 3, 1996
------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER(B) QUARTER(C) QUARTER QUARTER
---------- ---------- -------- --------
<S> <C> <C> <C> <C>
Sales................................................... $ 112,716 $ 135,428 $132,058 $274,289
Gross margin............................................ 58,875 70,327 68,773 142,487
Net income (loss)....................................... (5,381) 3,171 (2,760) 19,221
Net income (loss) per share
applicable to common shares (a):
Basic net income (loss) per share.................. (4.44) 0.43 (0.37) 2.60
Diluted net income (loss) per share................ (4.36) 0.42 (0.37) 2.55
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 1, 1997
--------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Sales................................................... $130,719 $137,188 $136,140 $281,227
Gross margin............................................ 66,681 71,343 70,360 146,590
Net income (loss)....................................... (4,400) (1,567) (2,637) 20,361
Net income (loss) per share
applicable to common shares (a):
Basic net income (loss) per share.................. (0.59) (0.21) (0.36) 2.74
Diluted net income (loss) per share................ (0.59) (0.21) (0.35) 2.67
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31, 1998
--------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Sales................................................... $134,592 $148,060 $148,770 $338,440
Gross margin............................................ 68,870 75,948 77,107 176,852
Net income (loss)....................................... (4,226) (1,378) (3,250) 24,049
Net income (loss) per share
applicable to common shares (a):
Basic net income (loss) per share.................. (0.57) (0.19) (0.42) 2.50
Diluted net income (loss) per share................ (0.56) (0.18) (0.42) 2.42
</TABLE>
(Footnotes on next page)
F-20
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
(Footnotes from previous page)
- ------------------
(a) Net income (loss) per share for each quarter is computed as if each quarter
were a discrete period. As such, the total of the four quarters net income
(loss) per share does not necessarily equal the net income (loss) per share
for the year.
(b) The first quarter of 1995 includes a $10,000,000 nonrecurring, noncash
charge relating to the conversion of the Series C Preferred Stock. See Note
5.
(c) The second quarter of 1995 includes proceeds of $5,000,000 from a life
insurance policy maintained on a senior executive.
NOTE 12--ACQUISITION
On October 6, 1997, Finlay completed the acquisition of certain assets of
the Diamond Park Fine Jewelers division of Zale Corporation ('Diamond Park'), a
leading operator of leased departments, for approximately $63.0 million, which
includes approximately $5.0 million for the purchase of additional inventory
acquired in March 1998 and the reimbursement of certain expenses incurred by the
Zale Corporation. By acquiring Diamond Park, Finlay added 139 departments and
also added new host store relationships with Mercantile Stores, Marshall Field's
and Parisian. Finlay financed the acquisition of Diamond Park (the 'Diamond Park
Acquisition') with borrowings under the Revolving Credit Agreement.
The Diamond Park Acquisition has been accounted for as a purchase, and,
accordingly, the operating results of the Diamond Park departments have been
included in the Company's consolidated financial statements since the date of
the acquisition. The Company has recorded goodwill of approximately $12.4
million and does not believe that the final purchase price allocation will
differ significantly from the preliminary purchase price allocation recorded at
January 31, 1998. Pursuant to the purchase agreement, the Company completed the
remaining components of the Diamond Park Acquisition in March 1998.
The preliminary purchase price allocation as of January 31, 1998 is as
follows:
<TABLE>
<S> <C> <C>
Payment for purchase of Diamond Park assets............................. $57,624
Inventory............................................................. 43,831
Fixed assets.......................................................... 4,443
Prepaid and other assets.............................................. 900
Acquisition and integration costs..................................... (2,600)
Other................................................................. (1,332)
------
Fair value of assets acquired and costs incurred........................ 45,242
-------
Goodwill................................................................ $12,382
-------
-------
</TABLE>
The following summarized, unaudited pro forma combined results of
operations for the years ended February 1, 1997 and January 31, 1998 have been
prepared assuming the Diamond Park Acquisition occurred at the beginning of the
respective periods. The pro forma information is provided for informational
purposes only. It is based on historical information, as well as certain
assumptions and estimates, and does not necessarily reflect the actual results
that would have occurred nor is it necessarily indicative of future results of
operations of the combined company (dollars in thousands, except per share
data):
<TABLE>
<CAPTION>
(UNAUDITED)
YEAR ENDED
--------------------------
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------
<S> <C> <C>
Sales............................................................. $ 778,145 $ 822,820
Net income (loss)................................................. $ 12,756 $ 13,928
Net income (loss) per share:
Basic net income (loss) per share............................... $ 1.72 $ 1.73
Diluted net income (loss) per share............................. $ 1.69 $ 1.68
</TABLE>
F-21
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 13--SUBSEQUENT EVENTS (UNAUDITED)
On March 19, 1998, Liberty House filed a voluntary petition in bankruptcy
under Title 11 of the United States Code. Finlay believes that the bankruptcy of
Liberty House will not have a material adverse effect on Finlay's financial
position or results of its operations.
On March 24, 1998, the Company filed a registration statement with the
Securities and Exchange Commission (the 'Commission') for a proposed public
offering of 1,600,000 shares of its Common Stock (the 'Equity Offering'), of
which 567,310 shares are expected to be issued and sold by the Company.
Concurrently with the filing of the registration statement relating to the
Equity Offering, the Company and Finlay Jewelry filed registration statements
with the Commission for the proposed public offering of $75.0 million aggregate
principal amount of Senior Debentures due 2008 (the 'Senior Debentures') and
$150.0 million aggregate principal amount of Senior Notes due 2008 (the 'Senior
Notes'), respectively. In addition, it is contemplated that, concurrently with
the consummation of the sale of the Senior Debentures and the Senior Notes, the
Revolving Credit Agreement will be amended to increase the line of credit
thereunder to $275.0 million and to make certain other changes. It is
contemplated that the net proceeds to the Company from the Equity Offering, the
sale of the Senior Debentures, the repayment of a note receivable of
approximately $1.3 million (including principal and interest) from an executive
officer and the repayment of approximately $2.6 million of an intercompany
liability by Finlay Jewelry (the 'Intercompany Repayment') will be used to
redeem the Company's Debentures. Finlay Jewelry will use the net proceeds from
the sale of the Senior Notes, together with available cash of approximately $1.0
million, to redeem Finlay Jewelry's Notes and to make the Intercompany
Repayment.
F-22
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Finlay Fine Jewelry Corporation:
We have audited the accompanying consolidated balance sheets of Finlay Fine
Jewelry Corporation (a Delaware corporation) and subsidiaries as of February 1,
1997 and January 31, 1998, and the related consolidated statements of
operations, changes in stockholder's equity and cash flows for the fifty-three
weeks ended February 3, 1996, the fifty-two weeks ended February 1, 1997 and the
fifty-two weeks ended January 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Finlay Fine Jewelry
Corporation and subsidiaries as of February 1, 1997 and January 31, 1998, and
the results of their operations and their cash flows for the fifty-three weeks
ended February 3, 1996, the fifty-two weeks ended February 1, 1997 and the
fifty-two weeks ended January 31, 1998, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
New York, New York
March 18, 1998
F-23
<PAGE>
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Sales................................................................... $ 654,491 $ 685,274 $ 769,862
Cost of sales........................................................... 314,029 330,300 371,085
----------- ----------- -----------
Gross margin.......................................................... 340,462 354,974 398,777
Selling, general and administrative expenses............................ 281,693 289,145 325,752
Depreciation and amortization........................................... 9,659 10,840 12,163
----------- ----------- -----------
Income (loss) from operations......................................... 49,110 54,989 60,862
Proceeds from life insurance............................................ (5,000) -- --
Interest expense, net................................................... 21,844 22,526 24,413
----------- ----------- -----------
Income (loss) before income taxes..................................... 32,266 32,463 36,449
Provision (credit) for income taxes..................................... 12,527 14,501 15,528
----------- ----------- -----------
Net income (loss)..................................................... $ 19,739 $ 17,962 $ 20,921
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-24
<PAGE>
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 20,392 $ 12,655
Accounts receivable--department stores.............................................. 15,362 20,772
Other receivables................................................................... 4,338 6,861
Merchandise inventories............................................................. 222,445 279,766
Prepaid expenses and other.......................................................... 1,438 1,782
----------- -----------
Total current assets................................................................ 263,975 321,836
----------- -----------
Fixed assets
Equipment, fixtures and leasehold improvements...................................... 73,223 95,257
Less--accumulated depreciation and amortization..................................... 21,423 28,249
----------- -----------
Fixed assets, net................................................................ 51,800 67,008
----------- -----------
Deferred charges and other assets..................................................... 5,770 8,339
Goodwill.............................................................................. 95,263 104,271
----------- -----------
Total assets..................................................................... $ 416,808 $ 501,454
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Current portion of long-term debt................................................... $ 2 $ --
Accounts payable--trade............................................................. 133,252 160,424
Accrued liabilities:
Accrued salaries and benefits.................................................... 15,061 12,694
Accrued miscellaneous taxes...................................................... 4,147 5,013
Accrued insurance................................................................ 762 215
Accrued interest................................................................. 3,833 3,902
Accrued management transition and consulting..................................... 1,787 1,092
Other............................................................................ 14,665 14,639
Income taxes payable................................................................ 13,970 15,853
Deferred income taxes............................................................... 804 1,220
Due to parent....................................................................... -- 41,079
----------- -----------
Total current liabilities...................................................... 188,283 256,131
Long-term debt........................................................................ 135,000 135,000
Other non-current liabilities......................................................... 7,115 8,497
----------- -----------
Total liabilities.............................................................. 330,398 399,628
----------- -----------
Stockholder's equity:
Common Stock, par value $.01 per share; authorized 5,000 shares; issued and
outstanding 1,000 shares......................................................... -- --
Additional paid-in capital.......................................................... 69,241 69,241
Distributions to investor group in excess of carryover basis........................ (24,390) (24,390)
Retained earnings................................................................... 44,609 63,818
Foreign currency translation adjustment............................................. (3,050) (6,843)
----------- -----------
Total stockholder's equity..................................................... 86,410 101,826
----------- -----------
Total liabilities and stockholder's equity..................................... $ 416,808 $ 501,454
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-25
<PAGE>
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DISTRIBUTIONS
COMMON STOCK TO INVESTOR FOREIGN
------------------- ADDITIONAL GROUP IN EXCESS CURRENCY TOTAL
NUMBER PAID-IN OF CARRYOVER RETAINED TRANSLATION STOCKHOLDER'S
OF SHARES AMOUNT CAPITAL BASIS EARNINGS ADJUSTMENT EQUITY
--------- ------- ---------- --------------- -------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 28, 1995.......... 1,000 $ -- $ 42,506 $ (24,390) $ 9,924 $ (334) $ 27,706
Net income (loss)................ -- -- -- -- 19,739 -- 19,739
Dividends on Common Stock........ -- -- -- -- (1,380 ) -- (1,380)
Foreign currency translation
adjustment..................... -- -- -- -- -- (413) (413)
Capital contribution from
parent......................... -- -- 26,735 -- -- -- 26,735
--------- ------- ---------- --------------- -------- ---------- -------------
Balance, February 3, 1996.......... 1,000 -- 69,241 (24,390) 28,283 (747) 72,387
Net income (loss)................ -- -- -- -- 17,962 -- 17,962
Dividends on Common Stock........ -- -- -- -- (1,636 ) -- (1,636)
Foreign currency translation
adjustment..................... -- -- -- -- -- (2,303) (2,303)
--------- ------- ---------- --------------- -------- ---------- -------------
Balance, February 1, 1997.......... 1,000 -- 69,241 (24,390) 44,609 (3,050) 86,410
Net income (loss)................ -- -- -- -- 20,921 -- 20,921
Dividends on Common Stock........ -- -- -- -- (1,712 ) -- (1,712)
Foreign currency translation
adjustment..................... -- -- -- -- -- (3,793) (3,793)
--------- ------- ---------- --------------- -------- ---------- -------------
Balance, January 31, 1998.......... 1,000 $ -- $ 69,241 $ (24,390) $63,818 $ (6,843) $ 101,826
--------- ------- ---------- --------------- -------- ---------- -------------
--------- ------- ---------- --------------- -------- ---------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-26
<PAGE>
FINLAY FINE JEWELRY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)..................................................... $ 19,739 $ 17,962 $ 20,921
Adjustments to reconcile net income (loss) to net cash provided from
(used in) operating activities:
Depreciation and amortization......................................... 10,587 11,871 13,195
Other, net............................................................ 797 1,845 1,495
Changes in operating assets and liabilities, net of effects from
purchase of Diamond Park assets (Note 11):
(Increase) decrease in accounts and other receivables.............. (9,856) 1,560 (8,806)
Increase in merchandise inventories................................ (35,601) (28,380) (15,360)
(Increase) decrease in prepaid expenses and other.................. (262) 66 385
Increase in accounts payable and accrued liabilities............... 10,515 9,300 22,038
Increase (decrease) in deferred income taxes....................... (539) (27) 416
Increase in due to parent.......................................... -- -- 40,030
----------- ----------- -----------
Net cash provided from (used in) operating activities............ (4,620) 14,197 74,314
----------- ----------- -----------
Cash flows from investing activities:
Purchases of equipment, fixtures and leasehold improvements........... (14,933) (17,533) (19,338)
Payment for puchase of Diamond Park assets............................ -- -- (57,642)
Other, net............................................................ (2,224) (839) (2,386)
----------- ----------- -----------
Net cash used in investing activities............................ (17,157) (18,372) (79,366)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from revolving credit facility............................... 439,720 442,947 564,510
Principal payments on revolving credit facility....................... (439,720) (442,947) (564,510)
Capital contribution from parent...................................... 26,735 -- --
Payment of dividends.................................................. (1,810) (818) --
Capitalized financing costs........................................... -- -- (2,347)
Other, net............................................................ (372) (206) (2)
----------- ----------- -----------
Net cash provided from (used in) financing activities............ 24,553 (1,024) (2,349)
----------- ----------- -----------
Effect of exchange rate changes on cash.......................... (221) (146) (336)
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents................. 2,555 (5,345) (7,737)
----------- ----------- -----------
Cash and cash equivalents, beginning of period.......................... 23,182 25,737 20,392
----------- ----------- -----------
Cash and cash equivalents, end of period................................ $ 25,737 $ 20,392 $ 12,655
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-27
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION OF THE COMPANY AND TRANSACTIONS
Finlay Fine Jewelry Corporation, a Delaware corporation (together with
its wholly owned subsidiaries, 'Finlay Jewelry'), is a wholly owned subsidiary
of Finlay Enterprises, Inc. (the 'Holding Company'). References to 'Finlay' mean
collectively, the Holding Company and Finlay Jewelry. Finlay is a retailer of
fine jewelry products and primarily operates leased fine jewelry departments in
department stores throughout the United States and France. All references herein
to leased departments refer to departments operated pursuant to license
agreements or other arrangements with host department stores.
PUBLIC OFFERINGS AND RELATED TRANSACTIONS
On October 21, 1997, the Holding Company completed a public offering (the
'1997 Offering') of 3,450,000 shares of its common stock, par value $.01 per
share ('Common Stock') at a price of $19.00 per share, of which 2,196,971 shares
were issued and sold by the Holding Company. An additional 1,253,029 shares were
sold by existing stockholders. The underwriters' over-allotment was exercised in
full. Net proceeds to the Holding Company from the 1997 Offering were
$38,124,000. The Holding Company purchased inventory using the net proceeds and
subsequently sold this inventory to Finlay Jewelry. In addition, Finlay Jewelry
was charged a service fee by the Holding Company of $1.9 million which is
included in Selling, general and administrative expenses in the accompanying
Consolidated Statements of Operations.
On April 6, 1995, the Holding Company completed an initial public offering
(the 'Initial Public Offering') of 2,500,000 shares of its Common Stock, at a
price of $14.00 per share. An additional 115,000 shares were sold by
non-management selling stockholders. Net proceeds from the Initial Public
Offering were $30,200,000 and were used to repurchase $6,103,000 accreted
balance of the Holding Company's 12% Senior Discount Debentures due 2005 (the
'Debentures') with the balance of the net proceeds used to reduce a portion of
the outstanding indebtedness under Finlay's revolving credit facility with
General Electric Capital Corporation ('G.E. Capital') and the other lenders
named thereto.
Immediately prior to the completion of the Initial Public Offering, the
holders of the Holding Company's 10% Series C Cumulative Preferred Stock
('Series C Preferred Stock') exchanged all outstanding shares of Series C
Preferred Stock with the Holding Company for 2,581,784 shares of Common Stock
(the 'Series C Exchange'). For purposes of the Series C Exchange, the
outstanding Series C Preferred Stock was (i) valued at its liquidation value of
$30,000,000 plus $6,145,000 of accrued dividends through the date of completion
of the Series C Exchange, paid in kind at a quarterly rate of 2.5%, and (ii)
exchanged for Common Stock at the initial public offering price of $14.00 per
share.
THE 1993 RECAPITALIZATION
In May 1993, an affiliate of Thomas H. Lee Company (together with its
affiliated transferees, the 'Lee Investors') and partnerships managed by Desai
Capital Management Incorporated (collectively, the 'Desai Investors'), acquired
36.8% and 24.5%, respectively, of the outstanding voting securities of the
Holding Company in a series of transactions which recapitalized the Holding
Company (the '1993 Recapitalization'). Following the 1993 Recapitalization,
management maintained a substantial equity interest in the Holding Company.
The 1993 Recapitalization included an investment by the Lee Investors and
the Desai Investors in units consisting of the Series C Preferred Stock and
Common Stock (the 'Lee/Desai Units'). Concurrently, certain other existing
classes of preferred stock and all outstanding warrants to purchase Common Stock
were redeemed. These equity related transactions resulted in the Lee Investors
and the Desai Investors obtaining 52.6% beneficial ownership of the outstanding
Common Stock.
The 1993 Recapitalization also included the public issuance by the Holding
Company of units consisting of Debentures and Common Stock, the public issuance
by Finlay Jewelry of the 10 5/8%
F-28
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--ORGANIZATION OF THE COMPANY AND TRANSACTIONS (CONTINUED)
Senior Notes due 2003 (the 'Notes') and the refinancing of Finlay's outstanding
term loans and revolving indebtedness with Westinghouse Credit Corporation
('WCC'). The WCC revolving credit facility was replaced by the revolving credit
facility with G.E. Capital. See Note 4.
ORGANIZATION AND THE 1988 LEVERAGED RECAPITALIZATION
Finlay Jewelry was initially incorporated on August 2, 1985 as SL Holdings
Corporation ('SL Holdings'). The Holding Company, incorporated on November 22,
1988, was organized by certain officers and directors (the 'Investor Group') of
SL Holdings to acquire certain operations of SL Holdings. In connection with the
reorganization ('1988 Leveraged Recapitalization'), which resulted in the merger
of a wholly owned subsidiary of the Holding Company into SL Holdings, SL
Holdings changed its name to Finlay Fine Jewelry Corporation and became a wholly
owned subsidiary of the Holding Company.
The 1988 Leveraged Recapitalization was accounted for as a purchase in the
accompanying financial statements. Accordingly, the excess of the purchase price
over the net assets of Finlay Jewelry has been assigned to goodwill. Since
certain members of the Investor Group beneficially owned shares of SL Holdings
before the 1988 Leveraged Recapitalization and owned shares of the Holding
Company after the 1988 Leveraged Recapitalization, the purchase method of
accounting does not apply to their ownership interest in SL Holdings.
Accordingly, for accounting purposes, stockholders' equity reflects the total
shares of SL Holdings owned by the Investor Group at their respective adjusted
historical costs, reduced by the consideration paid for the SL Holdings shares
owned by the Investor Group. This resulted in a reduction in stockholders'
equity of $24,390,000 and is reflected as Distributions to investor group in
excess of carryover basis in the accompanying Consolidated Balance Sheets.
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING AND PRESENTATION: The accompanying Consolidated
Financial Statements have been prepared on the accrual basis of accounting in
accordance with generally accepted accounting principles, which, for certain
financial statement accounts, requires the use of management's estimates. Actual
results may differ from these estimates.
FISCAL YEAR: Finlay Jewelry's fiscal year ends on the Saturday closest to
January 31. References to 1995, 1996 and 1997 relate to the fiscal years ended
on February 3, 1996, February 1, 1997 and January 31, 1998. Each of the fiscal
years includes 52 weeks except 1995, which includes 53 weeks.
MERCHANDISE INVENTORIES: Consolidated inventories are stated at the lower
of cost or market with cost for the domestic operations determined by the
last-in, first-out ('LIFO') method. Market represents estimated realizable value
after providing for a normal profit margin. The cost to Finlay of gold
merchandise sold on consignment, which typically varies with the price of gold,
is not fixed until the sale is reported to the vendor following the sale of the
merchandise. Finlay at times enters into futures contracts, such as options or
forwards, based upon the anticipated sales of gold product in order to hedge
against the risk arising from those payment arrangements. Changes in the market
value of futures contracts are accounted for as an addition to or reduction from
the inventory cost. For the years ended February 3, 1996, February 1, 1997 and
January 31, 1998, the gain/loss on open futures contracts was not material.
Finlay Jewelry did not have any open positions in futures contracts for gold at
February 1, 1997 or January 31, 1998.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization, except where
otherwise indicated, are computed by the straight-line method over the estimated
useful lives of the fixed assets ranging from three to thirty-nine years. In
1997, Finlay Jewelry capitalized $660,000 of interest in connection with the
construction of its warehouse and distribution facility. The capitalized
interest was
F-29
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
recorded as part of the asset to which it related and is being amortized over
the asset's estimated useful life.
PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include
the accounts of Finlay Jewelry and its wholly owned subsidiaries, Sonab
Holdings, Inc. and Sonab International, Inc. All significant intercompany
transactions have been eliminated in consolidation.
SOFTWARE DEVELOPMENT COSTS: Costs incurred for the routine operation and
maintenance of management information systems are expensed as incurred. It is
Finlay Jewelry's policy to capitalize significant amounts relating to software
purchased from third party software vendors as well as external consulting costs
incurred in the development and improvement of management information systems.
In 1998, Statement of Position No. 98-1, 'Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use' was issued, whereby
Finlay Jewelry will be required to capitalize certain internal payroll costs for
employees directly associated with the development of software for internal use.
Finlay Jewelry intends to adopt this statement in 1999, and does not expect it
to have a materal impact on its consolidated financial statements.
INTANGIBLE ASSETS ARISING FROM ACQUISITION: The excess purchase price paid
over the fair market value of net assets acquired ('Goodwill') was recorded in
accordance with Accounting Principles Board ('APB') Opinion No. 16--'Accounting
for Business Combinations' and is being amortized on a straight-line basis. The
Goodwill related to the 1988 Leveraged Recapitalization and the Diamond Park
Acquisition (as defined in Note 11) is being amortized over 40 years and 20
years, respectively. Finlay Jewelry continually evaluates the carrying value and
the economic useful life of Goodwill based on Finlay Jewelry's operating results
and the expected future net cash flows and will adjust the carrying value and
the related amortization periods, if and when appropriate. Amortization of
Goodwill for 1995, 1996 and 1997 totaled $3,149,000, $3,143,000 and $3,367,000,
respectively. Accumulated amortization of Goodwill at February 1, 1997 and
January 31, 1998 totaled $24,551,000 and $27,825,000, respectively.
FOREIGN CURRENCY TRANSLATION: Results of operations for Finlay Jewelry's
foreign subsidiary are translated into U.S. dollars using the average exchange
rates during the period, while assets and liabilities are translated using
current rates in accordance with Statement of Financial Accounting Standards
('SFAS') No. 52, 'Foreign Currency Translation'. The resulting translation
adjustments are recorded directly into a separate component of Stockholder's
equity. Transaction gains and losses are reported in net income and were not
significant in any year.
DEBT ISSUANCE COSTS: Debt issuance costs of $8,728,000 arising principally
from the 1993 Recapitalization are being amortized using the straight line
method over the terms of the related debt agreements. These debt issuance costs
totaled approximately $3,200,000 at February 1, 1997 and $4,700,000 at January
31, 1998. The debt issuance costs are reflected as a component of Deferred
charges and other assets in the accompanying Consolidated Balance Sheets.
Amortization of debt issuance costs for 1995, 1996 and 1997 totaled $872,000,
$889,000 and $889,000, respectively, and have been recorded as a component of
Interest expense, net in the accompanying Consolidated Statements of Operations.
COST OF SALES: Cost of sales includes the cost of merchandise sold, repair
expense, shipping, shrinkage and inventory losses. Buying and occupancy costs
such as lease and rental fees are not included in Cost of sales and are
reflected in Selling, general and administrative expenses in the accompanying
Consolidated Statements of Operations.
ADVERTISING COSTS: All costs associated with advertising are expensed in
the month that the advertising takes place. For 1995, 1996 and 1997, gross
advertising expenses were $39,862,000,
F-30
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
$43,747,000 and $47,913,000 and are included in Selling, general and
administrative expenses in the accompanying Consolidated Statements of
Operations.
STATEMENTS OF CASH FLOWS: Finlay Jewelry considers cash on hand, deposits
in banks and deposits in money market funds as cash and cash equivalents.
Interest paid during 1995, 1996 and 1997 was $21,027,000, $21,480,000 and
$23,347,000 (net of capitalized interest), respectively. Income taxes paid in
1995, 1996 and 1997 totaled $9,367,000, $9,320,000 and $10,630,000,
respectively. Refer to Note 11 for a discussion of the Diamond Park Acquisition.
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 because of the short-term
maturity of these instruments. Marketable securities are recorded in the
consolidated financial statements at current market values, which approximates
cost. The fair values of Finlay Jewelry's debt and off-balance sheet financial
instruments are disclosed in Note 4.
STOCK-BASED COMPENSATION: Stock-based compensation is recognized using the
intrinsic value method. For disclosure purposes, pro forma net income and
earnings per share are provided as if the fair value method had been applied.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS: SFAS No. 121,
'Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of', requires long-lived assets as well as identifiable intangibles
be reviewed for impairment whenever events or changes in circumstances indicate
the carrying amount of the assets may not be recoverable. Upon adoption of this
Statement in 1996 and to date, there was no impact on Finlay Jewelry's financial
position or results of operations.
SEASONALITY: A significant portion of Finlay's revenues are generated in
the fourth quarter due to the seasonality of the retail industry. As such,
results for interim periods are not indicative of annual results. Refer to Note
10 for unaudited quarterly financial data.
NOTE 3--MERCHANDISE INVENTORIES
Merchandise inventories consisted of the following:
<TABLE>
<CAPTION>
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------------
(IN THOUSANDS)
<S> <C> <C>
Jewelry goods--rings, watches and other fine jewelry
(specific identification basis)............................ $ 231,298 $ 286,289
Excess of specific identification cost over LIFO inventory
value...................................................... 8,853 6,523
----------- -----------------
$ 222,445 $ 279,766
----------- -----------------
----------- -----------------
</TABLE>
The LIFO method had the effect of decreasing Income (loss) before income
taxes in 1995 and 1996 by $943,000 and $1,919,000, respectively, and increasing
Income (loss) before income taxes in 1997 by $2,330,000. Finlay determines its
LIFO inventory value by utilizing selected producer price indices published for
jewelry and watches by the Bureau of Labor Statistics. Due to the application of
APB Opinion No. 16, inventory valued at LIFO for income tax reporting purposes
is approximately $21,000,000 lower than that for financial reporting purposes at
January 31, 1998.
Approximately $194,276,000 and $219,822,000 at February 1, 1997 and January
31, 1998, respectively, of merchandise received on consignment has been excluded
from Merchandise inventories and Accounts payable-trade in the accompanying
Consolidated Balance Sheets.
F-31
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--MERCHANDISE INVENTORIES (CONTINUED)
In August 1995, Finlay Jewelry entered into a gold consignment agreement
(the 'Gold Consignment Agreement') with Rhode Island Hospital Trust National
Bank ('RIHT'), which matures on May 31, 1998. The Gold Consignment Agreement
enables Finlay Jewelry to receive merchandise by providing gold, or otherwise
making payment, to certain vendors who currently supply Finlay with merchandise
on consignment. While the merchandise involved remains consigned, title to the
gold content of the merchandise transfers from the vendors to RIHT. As a result,
such vendors have reduced their working capital requirements and associated
financing costs. Consequently, Finlay has negotiated more favorable prices and
terms with the participating vendors.
Finlay can obtain, pursuant to the Gold Consignment Agreement, up to the
lesser of (i) 85,000 fine troy ounces or (ii) $25 million worth of gold, subject
to a formula as prescribed by the Gold Consignment Agreement. At February 1,
1997 and January 31, 1998, amounts outstanding under the Gold Consignment
Agreement totaled 36,916 and 39,676 fine troy ounces, respectively, valued at
approximately $12.8 million and $12.1 million, respectively. The purchase price
per ounce is based on the daily Second London Gold Fixing. For financial
statement purposes, the consigned gold is not included in Merchandise
inventories on Finlay Jewelry's Consolidated Balance Sheets and, therefore, no
related liability has been recorded. Under the Gold Consignment Agreement,
Finlay is required to pay a daily consignment fee on the dollar equivalent of
the fine gold value of the ounces of gold consigned thereunder. The daily
consignment fee is based on a floating rate which, as of February 1, 1997 and
January 31, 1998, was approximately 4.5% and 4.3%, respectively, per annum. In
addition, Finlay is required to pay an unused line fee of 0.5% if the amount of
gold consigned has a value equal to or less than $10 million. Included in
interest expense for the year ended February 1, 1997 and January 31, 1998 are
consignment fees of $638,000 and $725,000, respectively.
In conjunction with the Gold Consignment Agreement, Finlay Jewelry granted
RIHT a first priority perfected lien on, and a security interest in, specified
gold jewelry of participating vendors approved under the Gold Consignment
Agreement and a lien on proceeds and products of such jewelry subject to the
terms of an intercreditor agreement between RIHT and G.E. Capital.
The Gold Consignment Agreement requires Finlay Jewelry to comply with
certain covenants, including restrictions on the incurrence of certain
indebtedness, the incurrence or creation of liens, engaging in certain
transactions with affiliates and related parties and limitations on the payment
of dividends. The Gold Consignment Agreement also contains various financial
covenants, including fixed charge coverage ratio requirements and certain
maximum debt limitations. Finlay Jewelry was in compliance with all of its
financial covenants as of and for the year ended January 31, 1998.
NOTE 4--SHORT AND LONG-TERM DEBT
The Holding Company and Finlay Jewelry are parties to a credit agreement
with G.E. Capital and the other lenders thereto (the 'Revolving Credit
Agreement') which provides Finlay with a senior secured revolving line of credit
of up to $225 million (the 'Revolving Credit Facility'), a portion of which is
available to the Holding Company under certain circumstances. The Revolving
Credit Agreement provides Finlay with a facility maturing in March 2003, for
borrowings based on an advance rate of (i) up to 85% of eligible accounts
receivable and (ii) up to 60% of eligible owned inventory after taking into
account such reserves or offsets as G.E. Capital may deem appropriate (the
'Borrowing Base'). Eligibility criteria are established by G.E. Capital, which
retains the right to adjust the Borrowing Base in its reasonable judgement by
revising standards of eligibility, establishing reserves and/or increasing or
decreasing from time to time the advance rates (except that any increase in the
borrowing base rate percentage shall require the consent of the lenders). Finlay
Jewelry is permitted to use up to $30 million
F-32
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--SHORT AND LONG-TERM DEBT (CONTINUED)
of the Revolving Credit Agreement for the guarantee of letters of credit issued
for the account of Finlay Jewelry. The outstanding revolving credit balance and
letter of credit balance under the Revolving Credit Agreement are required to be
reduced each year to $50 million or less and $20 million or less, respectively,
for a 30 consecutive day period (the 'Balance Reduction Requirement'). However,
the indentures with respect to the Notes (the 'Note Indenture') and Debentures
(the 'Debenture Indenture') require Finlay to reduce the balance of the
Revolving Credit Agreement in each year to $10 million or less for a specified
25 consecutive day period. Funds available under the Revolving Credit Agreement
are utilized for working capital purposes.
Amounts outstanding under the Revolving Credit Agreement presently bear
interest at a rate equal to, at Finlay's option, (i) the Index Rate (as defined)
plus 0.5% or (ii) for one or more portions of the Revolving Credit Facility of
$1.0 million or any greater integral multiple thereof, adjusted LIBOR plus
1.5%. Commencing in late 1998, amounts outstanding under the Revolving Credit
Agreement will bear interest at a rate equal to, at Finlay's option, (i) the
Index Rate plus a margin ranging from zero to 1.0% or (ii) adjusted LIBOR plus a
margin ranging from 1.0% to 2.0%, in each case depending on the financial
performance of Finlay. 'Index Rate' is defined as the higher of (i) the rate
publicly quoted from time to time by The Wall Street Journal as the 'base rate
on corporate loans at large U.S. money center commercial banks' and (ii) the
Federal Funds Rate plus 50 basis points per annum. A letter of credit fee of
1.5% per annum of the face amount of letters of credit guaranteed under the
Revolving Credit Agreement and an unused facility fee equal to 0.375% per annum
on the average unused daily balance of the Revolving Credit Facility payable
monthly in arrears. Upon the occurrence (and during the continuance) of an event
of default under the Revolving Credit Agreement, interest would accrue at a rate
which is 2% in excess of the rate otherwise applicable, and would be payable
upon demand.
The Revolving Credit Agreement is secured by a first priority perfected
security interest in all of Finlay Jewelry's (and any subsidiary's) present and
future tangible and intangible assets, excluding any of Finlay Jewelry's lease
agreements which are not assignable without the lessor's consent.
The Revolving Credit Agreement contains customary covenants, including
limitations on capital expenditures, limitations on borrowing transactions
between Finlay and its officers, directors, employees and affiliates and
limitations on payments of dividends. In addition, the lenders have the right to
approve certain private sales of Common Stock. The Revolving Credit Agreement
also contains various financial covenants, including minimum earnings and fixed
charge coverage ratio requirements and certain maximum debt limitations. Finlay
was in compliance with all of its financial covenants as of and for the year
ended January 31, 1998.
There were no amounts outstanding at February 1, 1997 or January 31, 1998
under the Revolving Credit Agreement. The maximum amounts outstanding under the
Revolving Credit Agreement during 1995, 1996 and 1997 were $99,100,000,
$114,100,000 and $189,200,000, respectively. The average amounts outstanding for
the same periods were $68,400,000, $75,371,000 and $107,700,000, respectively.
The weighted average interest rates during the period were 8.9%, 8.0% and 7.9%
for 1995, 1996 and 1997, respectively.
At February 1, 1997 and January 31, 1998, Finlay had letters of credit
outstanding totaling $11.1 million and $10.3 million, respectively, which
guarantee various trade activities. The contract amount of the letters of credit
approximate their fair value.
F-33
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--SHORT AND LONG-TERM DEBT (CONTINUED)
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Senior Notes(a)................................................... $ 135,000 $ 135,000
Other............................................................. 2 --
----------- -----------
135,002 135,000
Less--current portion............................................. 2 --
----------- -----------
$ 135,000 $ 135,000
----------- -----------
----------- -----------
</TABLE>
- ------------------
(a) On May 26, 1993, as part of the 1993 Recapitalization, Finlay Jewelry issued
10 5/8% Senior Notes due 2003 with an aggregate principal amount of
$135,000,000. Interest on the Notes is payable semi-annually on May 1 and
November 1 of each year, and commenced on November 1, 1993. Except in the
case of certain equity offerings, the Notes are not redeemable prior to May
1, 1998. Thereafter, the Notes will be redeemable, in whole or in part, at
the option of Finlay, at specified redemption prices plus accrued and unpaid
interest, if any, to the date of the redemption. In the event of a Change of
Control (as defined in the Note Indenture), each holder of the Notes will
have the right to require Finlay Jewelry to repurchase its Notes at a
purchase price equal to 101% of the principal amount thereof plus accrued
and unpaid interest thereon to the repurchase date. The Notes rank senior in
right of payment to all subordinated indebtedness of Finlay and pari passu
in right of payment with all senior borrowings, including borrowings under
the Revolving Credit Agreement. However, because the Revolving Credit
Agreement is secured by a pledge of substantially all the assets of Finlay
Jewelry, the Notes are structurally subordinated to the borrowings under the
Revolving Credit Agreement. The Note Indenture contains restrictions
relating to, among other things, the payment of dividends, the repurchase of
stock and the making of certain other restricted payments, the incurrence of
additional indebtedness, the creation of certain liens, certain asset sales
transactions with subsidiaries and other affiliates and mergers and
consolidations.
The fair value of the Notes at January 31, 1998, determined based on market
quotes, was $141,750,000.
On May 26, 1993, as part of the 1993 Recapitalization, the Holding Company
sold, for $55,167,140, an aggregate of 98,000 units consisting of
$98,000,000 12% Senior Discount Debentures due 2005 and 130,667 shares of
Common Stock. The Debentures are secured by a first priority lien on and
security interest in all of the issued and outstanding stock and
intercompany indebtedness, if any, of Finlay Jewelry. However, the
operations of the Holding Company are conducted through Finlay Jewelry and,
therefore, the Holding Company is dependent upon the cash flow of Finlay
Jewelry to meet its obligations, including its obligations under the
Debentures. As a result, the Debentures are effectively subordinated to all
indebtedness and all other obligations of Finlay Jewelry. The Debenture
Indenture contains restrictions relating to, among other things, the payment
of dividends, the repurchase of stock and the making of certain other
restricted payments, the incurrence of additional indebtedness, the creation
of certain liens, certain asset sales transactions with subsidiaries and
other affiliates and mergers and consolidations.
Finlay was in compliance with all of the provisions of the Note and
Debenture Indentures as of and for the year ended January 31, 1998.
F-34
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--SHORT AND LONG-TERM DEBT (CONTINUED)
The aggregate amounts of long-term debt payable in each of the five years
in the period ending February 1, 2003 and thereafter are as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
1998...................................................... $ --
1999...................................................... --
2000...................................................... --
2001...................................................... --
2002...................................................... --
Thereafter................................................ 135,000
--------------
$135,000
--------------
--------------
</TABLE>
Interest expense for 1995, 1996 and 1997 was $21,985,000, $22,609,000 and
$24,448,000, respectively. Interest income for the same periods was $141,000,
$83,000 and $35,000, respectively.
NOTE 5--LONG TERM INCENTIVE PLANS AND MANAGEMENT PURCHASE OF COMMON STOCK
The Holding Company's Long Term Incentive Plan (the '1993 Plan') permits
the Holding Company to grant to key employees of the Holding Company and its
subsidiaries, consultants and certain other persons, and directors of the
Holding Company (other than members of the Compensation Committee of the Holding
Company's Board of Directors), the following: (i) stock options; (ii) stock
appreciation rights in tandem with stock options; (iii) limited stock
appreciation rights in tandem with stock options; (iv) restricted or
nonrestricted stock awards subject to such terms and conditions as the
Compensation Committee shall determine; (v) performance units which are based
upon attainment of performance goals during a period of not less than two nor
more than five years and which may be settled in cash or in Common Stock at the
discretion of the Compensation Committee; or (vi) any combination of the
foregoing. Under the 1993 Plan, the Holding Company may grant stock options
which are either incentive stock options within the meaning of Section 422 of
the Internal Revenue Code of 1986, as amended (the 'Code'), or non-incentive
stock options. As of January 31, 1998, an aggregate of 732,596 shares of the
Holding Company's Common Stock has been reserved for issuance pursuant to the
1993 Plan, of which a total of 640,052 shares are subject to options granted to
certain senior management, key employees and a director.
On March 6, 1997, the Board of Directors of the Holding Company adopted the
1997 Long Term Incentive Plan (the '1997 Plan'), which was approved by the
Holding Company's stockholders in June 1997. The 1997 Plan, which is similar to
the 1993 Plan, is intended as a successor to the 1993 Plan and provides for the
grant of the same types of awards as are currently available under the 1993
Plan. An aggregate of 350,000 shares of the Holding Company's Common Stock have
been reserved for issuance pursuant to the 1997 Plan, of which a total of
349,448 shares are subject to options granted to certain senior management, key
employees and a director. The exercise prices of such options range from $13.875
per share to $23.188 per share.
Finlay has adopted the disclosure-only provisions of SFAS No. 123,
'Accounting for Stock-Based Compensation,' which became effective in 1996. As
permitted by SFAS No. 123, Finlay has elected to continue to account for
stock-based compensation using the intrinsic value method. Accordingly, no
compensation expense has been recognized for its stock-based compensation plans.
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, Finlay Jewelry's net income would have
been reduced by $228,000 in 1995, $219,000 in 1996 and $330,000 in 1997. This
pro forma impact only reflects options granted since the beginning of 1995 and
therefore the resulting compensation cost may not be representative of that to
be expected in future years.
F-35
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--LONG TERM INCENTIVE PLANS AND MANAGEMENT PURCHASE OF COMMON STOCK
(CONTINUED)
The fair value of options granted in 1995, 1996 and 1997 was estimated
using the Black-Scholes option-pricing model based on the weighted average
market price at the grant date of $13.67 in 1995, $13.56 in 1996 and $14.95 in
1997 and the following weighted average assumptions: risk free interest rate of
6.89%, 6.67% and 6.57% for 1995, 1996 and 1997, respectively, expected life of
seven years for each of 1995, 1996 and 1997 and volatility of 35.10% for 1995
and 1996 and 32.98% for 1997. The weighted average fair value of options granted
in 1995, 1996 and 1997 was $7.02, $6.88 and $7.33, respectively.
The following summarizes the transactions pursuant to the Holding Company's
1993 Plan and 1997 Plan for 1995, 1996 and 1997:
<TABLE>
<CAPTION>
1995 1996 1997
---------------------- ---------------------- ----------------------
NUMBER OF WTD. AVG. NUMBER OF WTD. AVG. NUMBER OF WTD. AVG.
OPTIONS EX. PRICE OPTIONS EX. PRICE OPTIONS EX. PRICE
--------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year......... 396,821 $ 9.11 545,834 $11.61 523,767 $11.93
Granted.................................. 264,505 13.67 21,333 13.56 505,167 14.95
Exercised................................ (41,284) 7.23 (27,826) 7.23 (23,241) 8.74
Forfeited................................ (74,208) 8.00 (15,574) 11.45 (16,193) 11.25
--------- ---------- --------- ---------- --------- ----------
Outstanding at end of year............... 545,834 11.61 523,767 11.93 989,500 13.55
--------- ---------- --------- ---------- --------- ----------
--------- ---------- --------- ---------- --------- ----------
Exercisable at end of year............... 113,970 $ 9.73 207,122 $10.94 282,020 $11.47
</TABLE>
The options outstanding at January 31, 1998 have exercise prices between
$7.23 and $23.19, with a weighted average exercise price of $13.55 and a
weighted average remaining contractual life of 7.88 years. Options generally
vest in five years and expire in ten years from their dates of grant.
Upon the commencement of his employment, a senior officer of the Holding
Company purchased 138,525 shares of Common Stock (the 'Purchased Shares'), at a
price of $7.23 per share. The aggregate purchase price of these shares was paid
in the form of a note issued to the Holding Company in the amount of $1,001,538.
The note is secured by the Purchased Shares and certain proceeds from the sale
of the Purchased Shares or any distribution paid on or with respect to the
Purchased Shares. Interest accrues on the unpaid balance of the note at a rate
equal to 7.92% per annum, compounded annually. In the event of termination of
employment, the Purchased Shares (together with vested options and shares issued
upon exercise of vested options ('Option Shares')) are subject to certain call
rights and the Option Shares are additionally subject to certain put rights. In
the event the Holding Company does not exercise its call rights, the rights may
be exercised by the Lee Investors and the Desai Investors, pro rata based on
their respective ownership of Common Stock. The Purchased Shares and Option
Shares are subject to certain restrictions on transfer.
NOTE 6--LEASE AGREEMENTS
Finlay conducts substantially all of its operations as leased departments
in department stores. All of these leases, as well as rentals for office space
and equipment, are accounted for as operating leases. A substantial number of
such operating leases expire on various dates through 2008.
Substantially all of the department store leases provide that the title to
certain fixed assets of Finlay transfers upon termination of the leases, and
that Finlay will receive the undepreciated value of such fixed assets from the
host store in the event such transfers occur. The values of such fixed assets
are recorded at the inception of the lease arrangement and are reflected in the
accompanying Consolidated Balance Sheets.
F-36
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--LEASE AGREEMENTS (CONTINUED)
In many cases, Finlay is subject to limitations under its lease agreements
with host department stores which prohibit Finlay from operating departments for
other store groups within a certain geographical radius of the host store.
The store leases provide for the payment of fees based on sales, plus, in
some instances, installment payments for fixed assets. Lease expense, included
in Selling, general and administrative expenses, is as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Minimum fees........................................ $ 10,555 $ 6,188 $ 9,732
Contingent fees..................................... 94,679 103,319 115,331
----------- ----------- -----------
Total.......................................... $ 105,234 $ 109,507 $ 125,063
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
Future minimum payments under noncancellable operating leases having
initial or remaining noncancellable lease terms in excess of one year are as
follows as of January 31, 1998:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
1998...................................................... $ 24,824
1999...................................................... 19,830
2000...................................................... 12,552
2001...................................................... 6,231
2002...................................................... 2,086
Thereafter................................................ 11,001
--------------
Total minimum payments required...................... $ 76,524
--------------
--------------
</TABLE>
Minimum payments shown above have not been reduced by minimum sublease
payments of approximately $125,000 due in the future under noncancellable
subleases.
NOTE 7--PENSION PLANS
Finlay maintains a defined contribution profit-sharing plan to provide
retirement benefits for all personnel. This plan provides for company matching
contributions of $.25 for each $1.00 of employee contribution, up to 5% of the
employee's salary, as limited by the Code. Additionally, Finlay contributes 2%
of the employees' earnings annually, as limited by the Code. Vesting in Finlay's
contributions begins upon completion of three years of employment and accrues at
the rate of 20% per year.
Finlay also provides fixed retirement benefits for certain former employees
not covered by existing pension plans. The estimated liability for such benefits
has been accrued for in these financial statements and is reflected as
components of Other accrued liabilities and Other non-current liabilities.
The cost of the defined contribution plan maintained by Finlay and the
retirement benefits for certain former employees aggregated $1,728,000,
$1,753,000 and $1,771,000 for 1995, 1996 and 1997, respectively.
F-37
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--INCOME TAXES
For income tax reporting purposes, Finlay Jewelry has an October 31 year
end. Finlay Jewelry files a consolidated Federal income tax return with its
parent, the Holding Company, and its wholly owned subsidiaries. Finlay Jewelry's
provision for income taxes and deferred tax assets and liabilities was
calculated as if Finaly Jewelry filed its tax return on a stand-alone basis.
Deferred income taxes at year end reflect the impact of temporary
differences between amounts of assets and liabilities for financial and tax
reporting purposes.
Deferred tax assets and liabilities at year end are as follows:
<TABLE>
<CAPTION>
YEAR ENDED
--------------------------
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Deferred Tax Assets
Uniform inventory capitalization.................................................... $ 3,462 $ 3,569
Expenses not currently deductible................................................... 4,074 3,492
ITC carryover....................................................................... 1,100 950
AMT credit.......................................................................... 566 566
Deferred financing costs-current.................................................... 208 --
----------- -----------
9,410 8,577
Valuation allowance................................................................. 1,200 1,050
----------- -----------
Total current.................................................................. 8,210 7,527
----------- -----------
Deferred financing costs-non-current................................................ 429 293
----------- -----------
Total non-current.............................................................. 429 293
----------- -----------
Total deferred tax assets................................................... 8,639 7,820
----------- -----------
Deferred Tax Liabilities
LIFO inventory valuation............................................................ 9,014 8,747
----------- -----------
Total current.................................................................. 9,014 8,747
----------- -----------
Depreciation........................................................................ 7,029 8,295
----------- -----------
Total non-current.............................................................. 7,029 8,295
----------- -----------
Total deferred tax liabilities.............................................. 16,043 17,042
----------- -----------
Net deferred income tax liabilities....................................... $ 7,404 $ 9,222
----------- -----------
----------- -----------
Net current deferred income tax liabilities.................................... $ 804 $ 1,220
Net non-current deferred income tax liabilities................................ 6,600 8,002
----------- -----------
Net deferred income tax liabilities......................................... $ 7,404 $ 9,222
----------- -----------
----------- -----------
</TABLE>
The components of income tax expense are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
--------------------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Current domestic taxes................................................ $ 11,106 $ 12,291 $ 13,110
Current foreign taxes................................................. 1,238 1,045 600
Deferred taxes........................................................ 183 1,165 1,818
-------------- -------------- --------------
Income tax expense.................................................... $ 12,527 $ 14,501 $ 15,528
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
F-38
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--INCOME TAXES (CONTINUED)
A reconciliation of the income tax provision computed by applying the
federal statutory rate to Income (loss) before income taxes to the Provision for
income taxes on the accompanying Consolidated Statements of Operations is as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
--------------------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31,
1996 1997 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Federal Statutory Provision........................................... $ 11,294 $ 11,367 $ 12,757
Foreign taxes......................................................... 1,238 1,045 600
State tax, net of federal benefit..................................... 1,836 1,934 1,589
Non-deductible amortization........................................... 1,037 1,037 1,037
Life insurance proceeds............................................... (1,750) -- --
Benefit of foreign tax credit......................................... (1,238) (1,045) (600)
Other 110 163 145
-------------- -------------- --------------
Provision for income taxes............................................ $ 12,527 $ 14,051 $ 15,528
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
Section 382 of the Code restricts utilization of net operating loss
carryforwards ('NOLs') after an ownership change exceeding 50%. As a result of
the 1993 Recapitalization, a change in ownership of the Holding Company
exceeding 50% occurred within the meaning of Section 382 of the Code (a 'Change
of Control'). Similar restrictions will apply to other carryforwards.
Consequently, there is a material limitation on the annual utilization of Finlay
Jewelry's net operating loss and other carryforwards which requires a deferral
or loss of the utilization of such carryforwards. At October 31, 1997, Finlay
Jewelry has a NOL carryforward for tax purposes of $12,000,000 which is subject
to an annual limit of approximately $2,000,000 per year, of which $8,000,000
expires in 2004 and $4,000,000 expires in 2005. At October 31, 1997, Finlay
Jewelry had investment tax credit ('ITC') carryovers of approximately $950,000,
of which $649,000 expires in 1998, $264,000 in 1999 and $37,000 in 2000. At
October 31, 1997, Finlay Jewelry also had Alternative Minimum Tax Credit ('AMT')
carryovers of $566,000 which may be used indefinitely to reduce federal income
taxes. An additional change in ownership within the meaning of Section 382 of
the Code has occurred as a result of the 1997 Offering. However, there are no
additional restrictions upon Finlay Jewelry's ability to utilize its NOLs or
other carryforwards as a result of such ownership change.
SFAS No. 109 'Accounting for Income Taxes,' requires that the tax benefit
of such NOLs and tax credits be recorded as an asset to the extent that
management assesses the utilization to be 'more likely than not'. As the
accompanying Consolidated Financial Statements include profits earned after the
tax year end at October 31, (the profit of the year-end holiday season), for
financial reporting purposes only, the NOL carryforward has been absorbed in
full and no NOL carryfoward exists as of January 31, 1998. Management determined
at January 31, 1998, that based upon Finlay Jewelry's history of operating
earnings and its expectations for the future, no change to the valuation
allowance is warranted, with the exception of amounts utilized to offset the
expiration during 1997 of an ITC carryover.
NOTE 9--COMMITMENTS AND CONTINGENCIES
Finlay Jewelry, from time to time, is involved in litigation concerning its
business affairs. Management believes that the resolution of all pending
litigation will not have a material adverse effect on the consolidated financial
statements.
Finlay Jewelry has employment agreements with two senior members of
management which provide for minimum salary levels as well as incentive
compensation based on meeting specific financial goals. Such agreements have
remaining terms of one and three years. In addition, Finlay Jewelry has an
agreement with a senior member of management which provides for one year's
salary if employment is terminated without cause. Such agreements have a
remaining aggregate minimum value of approximately $3.9 million as of January
31, 1998.
F-39
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Revolving Credit Agreement, the Gold Consignment Agreement and the Note
Indenture currently restrict annual distributions from Finlay Jewelry to 0.25%
of Finlay Jewelry's net sales for the preceding fiscal year. During 1997,
dividends of $1,712,000 were declared. During 1996, dividends of $1,636,000 were
declared and $818,000 was distributed to the Holding Company. During 1995,
dividends of $1,380,000 were declared and $1,810,000 was distributed to the
Holding Company.
Finlay Jewelry's concentration of credit risk consists principally of
accounts receivable. Approximately 71%, 75% and 72% of Finlay's domestic sales
in 1995, 1996 and 1997, respectively, were from operations in two major
department store groups of which 48%, 51% and 49% represents Finlay's domestic
sales from one department store group in the respective years. Finlay Jewelry
believes that the risk associated with these receivables, other than those from
department store groups indicated above, would not have a material adverse
effect on Finlay Jewelry's financial position or results of operations.
Liberty House, one of the host stores in which Finlay operates, has
requested deferral of approximately $2.0 million of 1997 sales due to Finlay.
Finlay is currently receiving weekly payments against the outstanding balance.
NOTE 10--QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table summarizes the quarterly financial data for 1995, 1996
and 1997 (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 3, 1996
----------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER(A) QUARTER QUARTER
-------- ---------- -------- --------
<S> <C> <C> <C> <C>
Sales................................................... $112,716 $ 135,428 $132,058 $274,289
Gross margin............................................ 58,875 70,327 68,773 142,487
Net income (loss)....................................... (4,102) 4,545 (1,373) 20,669
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 1, 1997
--------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Sales................................................... $130,719 $137,188 $136,140 $281,227
Gross margin............................................ 66,681 71,343 70,360 146,590
Net income (loss)....................................... (2,929) (15) (1,091) 21,997
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 31, 1998
--------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Sales................................................... $134,592 $148,060 $148,770 $338,440
Gross margin............................................ 68,870 75,948 77,107 176,852
Net income (loss)....................................... (2,599) 351 (2,549) 25,718
</TABLE>
- ------------------------
(a) The second quarter of 1995 includes proceeds of $5,000,000 from a life
insurance policy maintained on a senior executive.
NOTE 11--ACQUISITION
On October 6, 1997, Finlay completed the acquisition of certain assets of
the Diamond Park Fine Jewelers division of Zale Corporation ('Diamond Park'), a
leading operator of leased departments, for approximately $63.0 million, which
includes approximately $5.0 million for the purchase of additional inventory
acquired in March 1998 and the reimbursement of certain expenses incurred by the
Zale Corporation. By acquiring Diamond Park, Finlay added 139 departments and
also added new host store relationships with Mercantile Stores, Marshall Field's
and Parisian. Finlay financed the acquisition of Diamond Park (the 'Diamond Park
Acquisition') with borrowings under the Revolving Credit Agreement.
F-40
<PAGE>
FINLAY FINE JEWELRY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--ACQUISITION (CONTINUED)
The Diamond Park Acquisition has been accounted for as a purchase, and,
accordingly, the operating results of the Diamond Park departments have been
included in Finlay Jewelry's consolidated financial statements since the date of
the acquisition. Finlay Jewelry has recorded goodwill of approximately $12.4
million and does not believe that the final purchase price allocation will
differ significantly from the preliminary purchase price allocation recorded at
January 31, 1998. Pursuant to the purchase agreement, Finlay completed the
remaining components of the Diamond Park Acquisition in March 1998.
The preliminary purchase price allocation as of January 31, 1998 is as
follows:
<TABLE>
<S> <C> <C>
Payment for purchase of Diamond Park assets..................................... $57,624
Inventory..................................................................... 43,831
Fixed assets.................................................................. 4,443
Prepaid and other assets...................................................... 900
Acquisition and integration costs............................................. (2,600)
Other......................................................................... (1,332)
-------
Fair value of assets acquired and costs incurred................................ 45,242
-------
Goodwill........................................................................ $12,382
-------
-------
</TABLE>
The following summarized, unaudited pro forma combined results of
operations for the years ended February 1, 1997 and January 31, 1998 have been
prepared assuming the Diamond Park Acquisition occurred at the beginning of the
respective periods. The pro forma information is provided for informational
purposes only. It is based on historical information, as well as certain
assumptions and estimates, and does not necessarily reflect the actual results
that would have occurred nor is it necessarily indicative of future results of
operations of the combined company (dollars in thousands):
<TABLE>
<CAPTION>
(UNAUDITED)
YEAR ENDED
--------------------------
FEBRUARY 1, JANUARY 31,
1997 1998
----------- -----------
<S> <C> <C>
Sales............................................................. $ 778,145 $ 822,820
Net income (loss)................................................. $ 18,961 $ 19,654
</TABLE>
NOTE 12--SUBSEQUENT EVENTS (UNAUDITED)
On March 19, 1998, Liberty House filed a voluntary petition in bankruptcy
under Title 11 of the United States Code. Finlay believes that the bankruptcy of
Liberty House will not have a material adverse effect on Finlay's financial
position or results of its operations.
On March 24, 1998, the Holding Company filed a registration statement with
the Securities and Exchange Commission (the 'Commission') for a proposed public
offering of 1,600,000 shares of its Common Stock (the 'Equity Offering'), of
which 567,310 shares are expected to be issued and sold by the Holding Company.
Concurrently with the filing of the registration statement relating to the
Equity Offering, the Holding Company and Finlay Jewelry filed registration
statements with the Commission for the proposed public offering of $75.0 million
aggregate principal amount of Senior Debentures due 2008 (the 'Senior
Debentures') and $150.0 million aggregate principal amount of Senior Notes due
2008 (the 'Senior Notes'), respectively. In addition, it is contemplated that
concurrently with the sale of the Senior Debentures and the Senior Notes, the
Revolving Credit Agreement will be amended to increase the line of credit
thereunder to $275.0 million and to make certain other changes. It is
contemplated that the net proceeds to the Holding Company from the Equity
Offering, the sale of the Senior Debentures, the repayment of a note receivable
of approximately $1.3 million (including principal and interest) from an
executive officer and the repayment of approximately $2.6 million of an
intercompany liability by Finlay Jewelry (the 'Intercompany Repayment') will
be used to redeem the Holding Company's Debentures. Finlay Jewelry will use the
net proceeds from the sale of the Senior Notes, together with available cash of
approximately $1.0 million, to redeem Finlay Jewelry's Notes and to make the
Intercompany Repayment.
F-41
<PAGE>
EXHIBIT 11--EARNINGS PER COMMON SHARE
EARNINGS PER COMMON SHARE WERE COMPUTED AS FOLLOWS:
<TABLE>
<CAPTION>
IN THOUSANDS, EXCEPT SHARE JANUARY 29, JANUARY 28, FEBRUARY 3, FEBRUARY 1, JANUARY 31,
AND PER SHARE AMOUNTS 1994 1995 1996 1997 1998
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Net income (loss).......................... $ (9,205) $ 2,731 $ 14,251 $ 11,757 $ 15,195
Less:
Dividends and amortization of discount on
preferred stock and accretion on
conversion of preferred stock......... 3,594 3,332 10,717 -- --
----------- ----------- ----------- ----------- -----------
Adjusted net income (loss)................. $ (12,799) $ (601) $ 3,534 $ 11,757 $ 15,195
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Weighted average shares--
Common (1)............................... 1,972,997 2,256,107 6,458,563 7,417,343 8,050,346
Common stock equivalents
pursuant to SFAS No. 128 (2)............. 138,525 138,525 181,164 152,186 225,588
----------- ----------- ----------- ----------- -----------
Total weighted average shares and share
equivalents.............................. 2,111,522 2,394,632 6,639,727 7,569,529 8,275,934
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Net income (loss) per share
applicable to common shares:
Basic net income (loss) per share........ $ (6.49) $ (0.27) $ 0.55 $ 1.59 $ 1.89
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Diluted net income (loss) per share...... $ (6.06) $ (0.25) $ 0.53 $ 1.55 $ 1.84
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
</TABLE>
- ------------------
(1) The weighted average shares outstanding are based on the number of shares of
Common Stock issued and outstanding.
(2) In accordance with SFAS No. 128, the common stock equivalents were
calculated by applying the treasury stock method. In addition, the Purchased
Shares, as discussed in Note 6 to Notes of Consolidated Financial
Statements, are considered outstanding for all periods prior to the Initial
Public Offering.
2
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our report included in this Form 10-K into the Company's previously filed
Registration Statements on Form S-8 File Nos. 33-99176 and 333-40967.
ARTHUR ANDERSEN LLP
New York, New York
March 24, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINLAY
ENTERPRISES, INC. FORM 10K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> FEB-02-1997
<PERIOD-END> JAN-31-1998
<CASH> 13,588
<SECURITIES> 0
<RECEIVABLES> 20,772
<ALLOWANCES> 0
<INVENTORY> 279,766
<CURRENT-ASSETS> 322,769
<PP&E> 95,257
<DEPRECIATION> 28,249
<TOTAL-ASSETS> 508,236
<CURRENT-LIABILITIES> 214,374
<BONDS> 221,026
0
0
<COMMON> 98
<OTHER-SE> 72,241
<TOTAL-LIABILITY-AND-EQUITY> 508,236
<SALES> 769,862
<TOTAL-REVENUES> 769,862
<CGS> 371,085
<TOTAL-COSTS> 371,085
<OTHER-EXPENSES> 336,940
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 34,115
<INCOME-PRETAX> 27,722
<INCOME-TAX> 12,527
<INCOME-CONTINUING> 15,195
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,195
<EPS-PRIMARY> 1.89
<EPS-DILUTED> 1.84
</TABLE>
