- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended October 31, 1998
or
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _________ to __________
Commission File Number: 0-25716
FINLAY ENTERPRISES, INC.
--------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3492802
- -------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
529 Fifth Avenue, New York, NY 10017
---------------------------------------- ----------
(Address of principal executive offices) (zip code)
(212) 808-2800
----------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ____
As of December 11, 1998, there were 10,402,653 shares of common stock, par value
$.01 per share, of the Registrant outstanding.
<PAGE>
FINLAY ENTERPRISES, INC
FORM 10-Q
QUARTERLY PERIOD ENDED OCTOBER 31, 1998
INDEX
PAGE(S)
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Statements of Operations for the thirteen weeks and
thirty-nine weeks ended November 1, 1997 and October 31, 1998........1
Consolidated Balance Sheets as of January 31, 1998 and
October 31, 1998.....................................................3
Consolidated Statements of Changes in Stockholders' Equity for
the year ended January 31, 1998 and thirty-nine weeks ended
October 31, 1998.....................................................4
Consolidated Statements of Cash Flows for the thirteen weeks and
thirty-nine weeks ended November 1, 1997 and October 31, 1998........5
Notes to Consolidated Financial Statements...........................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......................13
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K....................................21
SIGNATURES...................................................................22
<PAGE>
PART 1 - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)
<TABLE>
<CAPTION>
Thirteen Weeks Ended
-----------------------------
November 1, October 31,
1997 1998
------------ -----------
<S> <C> <C>
Sales....................................................... $ 148,770 $ 165,894
Cost of sales............................................... 71,663 81,207
------------ -----------
Gross margin............................................. 77,107 84,687
Selling, general and administrative expenses................ 70,086 78,927
Depreciation and amortization............................... 3,022 3,916
------------ -----------
Income (loss) from operations............................ 3,999 1,844
Interest expense, net....................................... 9,149 8,153
------------ -----------
Income (loss) before income taxes........................ (5,150) (6,309)
Provision (credit) for income taxes......................... (1,900) (2,458)
------------ -----------
Net income (loss)........................................ $ (3,250) $ (3,851)
============ ===========
Net income (loss) per share applicable to common shares:
Basic net income (loss) per share........................ $ (0.42) $ (0.37)
============ ===========
Diluted net income (loss) per share...................... $ (0.42) $ (0.37)
============ ===========
Weighted average shares and share equivalents outstanding... 7,806,614 10,402,653
============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE>
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)
<TABLE>
<CAPTION>
Thirty-Nine Weeks Ended
-----------------------------
November 1, October 31,
1997 1998
------------ -----------
<S> <C> <C>
Sales....................................................... $ 431,422 $ 504,252
Cost of sales............................................... 209,497 246,620
------------ -----------
Gross margin............................................. 221,925 257,632
Selling, general and administrative expenses................ 201,677 235,874
Depreciation and amortization............................... 8,714 11,617
------------ -----------
Income (loss) from operations............................ 11,534 10,141
Interest expense, net....................................... 25,297 25,183
Nonrecurring interest associated with refinancing........... - 655
------------ -----------
Income (loss) before income taxes and extraordinary charges (13,763) (15,697)
Provision (credit) for income taxes......................... (4,909) (5,927)
------------ -----------
Income (loss) before extraordinary charges............... (8,854) (9,770)
Extraordinary charges from early extinguishment of debt,
net of income tax benefit of $4,765.................... - 7,415
------------ -----------
Net income (loss)........................................ $ (8,854) $ (17,185)
============ ===========
Net income (loss) per share applicable to common shares:
Basic net income (loss) per share:
Before extraordinary charges.......................... $ (1.18) $ (0.96)
============ ===========
Extraordinary charges from early extinguishment of debt $ - $ (0.73)
============ ===========
Net income (loss)..................................... $ (1.18) $ (1.69)
============ ===========
Diluted net income (loss) per share:
Before extraordinary charges.......................... $ (1.16) $ (0.96)
============ ===========
Extraordinary charges from early extinguishment of debt $ - $ (0.73)
============ ===========
Net income (loss)..................................... $ (1.16) $ (1.69)
============ ===========
Weighted average shares and share equivalents outstanding... 7,601,036 10,171,712
============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
FINLAY ENTERPRISES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
(unaudited)
January 31, October 31,
1998 1998
----------- -----------
ASSETS
Current assets
<S> <C> <C>
Cash and cash equivalents...................................... $ 13,588 $ 3,434
Accounts receivable - department stores........................ 20,772 36,750
Other receivables.............................................. 6,862 34,513
Merchandise inventories........................................ 279,766 325,756
Prepaid expenses and other..................................... 1,781 4,919
----------- -----------
Total current assets......................................... 322,769 405,372
----------- -----------
Fixed assets
Equipment, fixtures and leasehold improvements................. 95,257 106,869
Less - accumulated depreciation and amortization............... 28,249 36,399
----------- -----------
Fixed assets, net............................................ 67,008 70,470
----------- -----------
Deferred charges and other assets................................ 14,188 14,872
Goodwill......................................................... 104,271 101,451
----------- -----------
Total assets................................................. $ 508,236 $ 592,165
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable.................................................. $ - $ 150,122
Accounts payable - trade....................................... 160,434 87,207
Accrued liabilities:
Accrued salaries and benefits................................ 12,694 11,761
Accrued miscellaneous taxes.................................. 5,014 4,584
Accrued insurance............................................ 215 993
Accrued interest............................................. 3,902 10,520
Accrued management transition and consulting................. 1,092 742
Other........................................................ 15,558 15,526
Income taxes payable........................................... 14,246 -
Deferred income taxes.......................................... 1,219 1,702
----------- -----------
Total current liabilities.................................... 214,374 283,157
Long-term debt................................................... 221,026 225,000
Other non-current liabilities.................................... 497 9,073
----------- -----------
Total liabilities............................................ 435,897 517,230
----------- -----------
Stockholders' equity
Common Stock, par value $.01 per share; authorized 25,000,000
shares; issued and outstanding 9,779,050 and 10,402,653
shares, respectively.......................................... 98 104
Additional paid-in capital ..................................... 86,135 101,442
Distributions to investor group in excess of carryover basis.... (24,390) (24,390)
Note receivable from stock sale................................. (1,001) -
Retained earnings (deficit)..................................... 18,340 1,155
Foreign currency translation adjustment......................... (6,843) (3,376)
----------- -----------
Total stockholders' equity................................... 72,339 74,935
----------- -----------
Total liabilities and stockholders' equity................... $ 508,236 $ 592,165
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands, except share data)
<TABLE>
<CAPTION>
Distributions
to
Common Stock investor group Note Foreign
------------------- Additional in Receivable Retained Currency Total
Number Paid-in excess of from Earnings Translation Stockholders'
of shares Amount Capital carryover basis Stock Sale (Deficit) Adjustment Equity
----------- ------ ----------- ---------------- ----------- ----------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, February 1, 1997.. 7,558,838 $ 76 $ 47,725 $ (24,390) $ (1,001) $ 3,145 $ (3,050) $ 22,505
Net income (loss)......... - - - - - 15,195 - 15,195
Foreign currency
translation adjustment... - - - - - - (3,793) (3,793)
Issuance of Common Stock.. 2,196,971 22 38,102 - - - - 38,124
Exercise of stock options. 23,241 - 308 - - - - 308
---------- ----- ----------- ---------------- ----------- ----------- ----------- -------------
Balance, January 31, 1998.. 9,779,050 98 86,135 (24,390) (1,001) 18,340 (6,843) 72,339
Net income (loss)......... - - - - - (17,185) - (17,185)
Foreign currency
translation adjustment... - - - - - - 3,467 3,467
Issuance of Common Stock.. 567,310 6 13,753 - - - - 13,759
Note receivable repayment - - - - 1,001 - - 1,001
Exercise of stock options. 56,293 - 1,554 - - - - 1,554
---------- ----- ----------- ---------------- ----------- ----------- ----------- -------------
Balance, October 31, 1998
(unaudited).............. 10,402,653 $ 104 $ 101,442 $ (24,390) $ - $ 1,155 $ (3,376) $ 74,935
========== ===== =========== ================ =========== =========== =========== =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Thirteen Weeks Ended
-------------------------
November 1, October 31,
1997 1998
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net income (loss)................................................ $ (3,250) $ (3,851)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization.................................... 3,336 4,216
Imputed interest on debentures................................... 2,385 -
Other, net....................................................... (510) (398)
Changes in operating assets and liabilities, net of effects from
purchase of Diamond Park assets (Note 6):
Increase in accounts and other receivables..................... (6,313) (12,742)
Increase in merchandise inventories............................ (44,811) (16,478)
Increase in prepaid expenses and other......................... (49) (1,203)
Increase in accounts payable and accrued liabilities........... 26,574 16,125
---------- -----------
NET CASH USED IN OPERATING ACTIVITIES....................... (22,638) (14,331)
---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment, fixtures and leasehold improvements...... (6,829) (4,483)
Payment for purchase of Diamond Park assets...................... (57,642) -
Deferred charges and other, net.................................. (90) (3,088)
---------- -----------
NET CASH USED IN INVESTING ACTIVITIES....................... (64,561) (7,571)
---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility.......................... 162,478 139,894
Principal payments on revolving credit facility.................. (103,804) (118,467)
Capitalized financing costs...................................... (1,954) (36)
Net proceeds from public offering of Common Stock................ 38,124 -
Other, net....................................................... (1) 775
---------- -----------
NET CASH PROVIDED FROM FINANCING ACTIVITIES................. 94,843 22,166
---------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH..................... 237 280
---------- -----------
INCREASE IN CASH AND CASH EQUIVALENTS....................... 7,881 544
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD..................... 3,453 2,890
---------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD........................... $ 11,334 $ 3,434
========== ===========
Supplemental disclosure of cash flow information:
Interest paid.................................................... $ 2,462 $ 2,989
Income taxes paid................................................ 1,136 (811)
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
FINLAY ENTERPRISES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Thirty-Nine Weeks Ended
-------------------------
November 1, October 31,
1997 1998
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net income (loss)................................................ $ (8,854) $ (17,185)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization.................................... 9,651 12,575
Imputed interest on debentures................................... 7,019 2,527
Write-off of deferred financing costs and debt discount.......... - 3,900
Redemption premiums.............................................. - 7,102
Other extraordinary charges from early extinguishment of debt.... - 1,178
Other, net....................................................... (1,461) (83)
Changes in operating assets and liabilities, net of effects from
purchase of Diamond Park assets (Note 6):
Increase in accounts and other receivables..................... (24,580) (43,130)
Increase in merchandise inventories............................ (46,957) (43,302)
Increase in prepaid expenses and other......................... (724) (3,079)
Decrease in accounts payable and accrued liabilities........... (75,079) (67,982)
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES....................... (140,985) (147,479)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment, fixtures and leasehold improvements...... (15,306) (11,661)
Payment for purchase of Diamond Park assets...................... (57,642) -
Deferred charges and other, net.................................. (1,808) (3,830)
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES....................... (74,756) (15,491)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from revolving credit facility.......................... 459,587 643,436
Principal payments on revolving credit facility.................. (289,391) (493,314)
Prepayment of notes.............................................. - (135,000)
Prepayment of debentures......................................... - (89,293)
Payment of redemption premiums................................... - (7,102)
Net proceeds from public offering of Common Stock................ 38,124 13,759
Proceeds from senior note offering............................... - 150,000
Proceeds from senior debenture offering.......................... - 75,000
Proceeds from repayment of note receivable....................... - 1,001
Capitalized financing costs...................................... (1,954) (6,180)
Other, net....................................................... 125 378
----------- -----------
NET CASH PROVIDED FROM FINANCING ACTIVITIES................. 206,491 152,685
----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH..................... (262) 131
----------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS....................... (9,512) (10,154)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD..................... 20,846 13,588
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD........................... $ 11,334 $ 3,434
=========== ===========
Supplemental disclosure of cash flow information:
Interest paid.................................................... $ 13,010 $ 15,735
Income taxes paid................................................ 9,149 300
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Finlay
Enterprises, Inc. (the "Company" or the "Registrant"), and its wholly owned
subsidiary, Finlay Fine Jewelry Corporation and its wholly owned subsidiaries
("Finlay Jewelry"), have been prepared in accordance with generally accepted
accounting principles for interim financial information. References to "Finlay"
mean collectively, the Company and Finlay Jewelry. In the opinion of management,
the accompanying unaudited consolidated financial statements contain all
adjustments necessary to present fairly the financial position of the Company as
of October 31, 1998, and the results of operations and cash flows for the
thirteen weeks and thirty-nine weeks ended November 1, 1997 and October 31,
1998. Due to the seasonal nature of the business, results for interim periods
are not indicative of annual results. The unaudited consolidated financial
statements have been prepared on a basis consistent with that of the audited
consolidated financial statements as of January 31, 1998 referred to below.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission (the "Commission").
These consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto included in the
Company's annual report on Form 10-K for the fiscal year ended January 31, 1998
("Form 10-K") previously filed with the Commission.
Finlay's fiscal year ends on the Saturday closest to January 31. References
to 1995, 1996, 1997 and 1998 relate to the fiscal years ending February 3, 1996,
February 1, 1997, January 31, 1998 and January 30, 1999, respectively. Each of
the fiscal years includes fifty-two weeks except 1995, which includes
fifty-three weeks.
Net income (loss) per share has been computed in accordance with the
Statement of Financial Accounting Standards ("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
the prior 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>
Thirteen Weeks Ended Thirty-Nine Weeks Ended
------------------------------------------- ------------------------------------------------
November 1, 1997 October 31, 1998 November 1, 1997 October 31, 1998
-------------------- --------------------- ---------------------- -----------------------
Weighted average shares
<S> <C> <C> <C> <C> <C> <C> <C> <C>
outstanding............ 7,720,663 $ (0.42) 10,402,653 $ (0.37) 7,521,391 $ (1.18) 10,171,712 $ (1.69)
Dilutive stock options 85,951 - - - 79,645 0.02 - -
----------- -------- ------------ -------- ----------- --------- ------------ ----------
Weighted average shares
and share equivalents.. 7,806,614 $ (0.42) 10,402,653 $ (0.37) 7,601,036 $ (1.16) 10,171,712 $ (1.69)
=========== ======== ============ ======== =========== ========= ============ ==========
</TABLE>
For each of the periods above, there were no adjustments to the Net income
(loss) applicable to common shares used to calculate basic and diluted net
income (loss) per share.
7
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION (continued)
During the first quarter of 1998, the Company adopted SFAS No. 130,
"Reporting Comprehensive Income", which became effective for fiscal years
beginning after December 15, 1997. This Statement requires disclosure of
comprehensive income, defined as the total of net income and all other nonowner
changes in equity, which under generally accepted accounting principles, are
recorded directly to the stockholders' equity section of the consolidated
balance sheet and, therefore bypass net income. In Finlay's case, the only
nonowner change in equity relates to the foreign currency translation
adjustment.
Comprehensive income (loss) is as follows (in thousands):
<TABLE>
<CAPTION>
Thirteen Weeks Ended Thirty-Nine Weeks Ended
---------------------------- --------------------------
November 1, October 31, November 1, October 31,
1997 1998 1997 1998
------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
Net income (loss)............................. $ (3,250) $ (3,851) $ (8,854) $ (17,185)
Foreign currency translation adjustment, net.. 1,718 1,850 (1,015) 2,063
------------ ------------ ----------- -----------
Comprehensive income (loss)................... $ (1,532) $ (2,001) $ (9,869) $ (15,122)
============ ============ =========== ===========
</TABLE>
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". The Statement
establishes accounting and reporting standards requiring that all derivative
instruments be recorded in the balance sheet as either an asset or liability
measured at its fair value and that changes in the derivative's fair value be
recognized currently in earnings. At October 31, 1998, the Company did not have
any open positions in futures contracts for gold or other outstanding derivative
instruments. SFAS No. 133 is effective for fiscal years beginning after June 15,
1999 and is not expected to have a material impact on the Company's financial
position or results of operations.
NOTE 2 - DESCRIPTION OF BUSINESS
The Company conducts business through its wholly owned subsidiary, Finlay
Jewelry. Finlay is a retailer of fine jewelry products and primarily operates
leased fine jewelry department stores throughout the United States and France.
Over the past three fiscal years, the fourth quarter accounted for an average of
42% of Finlay's sales due to the seasonality of the retail industry.
Approximately 72% of Finlay's domestic sales in 1997 were from operations in May
Department Stores ("May") and departments operated in store groups owned by
Federated Departments Stores, of which 49% represents Finlay's domestic sales in
May.
8
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - MERCHANDISE INVENTORIES
Merchandise inventories consisted of the following:
<TABLE>
<CAPTION>
(unaudited)
January 31, October 31,
1998 1998
----------- ------------
(in thousands)
Jewelry goods - rings, watches and other fine jewelry
<S> <C> <C>
(specific identification basis)....................... $ 286,289 $ 331,756
Less: Excess of specific identification cost over LIFO
inventory value...................................... 6,523 6,000
----------- ------------
$ 279,766 $ 325,756
=========== ============
</TABLE>
The LIFO method had the effect of decreasing the loss before income taxes
for the thirteen weeks ended November 1, 1997 and October 31, 1998 by $655,000
and $177,000, respectively. The effect of applying the LIFO method for the
thirty-nine weeks ended November 1, 1997 and October 31, 1998 was to decrease
the loss before income taxes by $655,000 and $523,000, respectively. Finlay
determines its LIFO inventory value by utilizing selected producer price indices
published for jewelry and watches by the Bureau of Labor Statistics.
Approximately $219,822,000 and $315,730,000 at January 31, 1998 and October
31, 1998, respectively, of merchandise received on consignment has been excluded
from Merchandise inventories and Accounts payable-trade in the accompanying
Consolidated Balance Sheets.
Finlay Jewelry is party to a gold consignment agreement (the "Gold
Consignment Agreement"), which expires on December 31, 2001. The Gold
Consignment Agreement enables Finlay Jewelry to receive merchandise by providing
gold, or otherwise making payment, to certain vendors who 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. Finlay Jewelry can obtain, pursuant to the Gold Consignment
Agreement, up to the lesser of (i) 85,000 fine troy ounces or (ii) $32,000,000
worth of gold, subject to a formula as prescribed by the Gold Consignment
Agreement. At October 31, 1998, amounts outstanding under the Gold Consignment
Agreement totaled 64,313 fine troy ounces, valued at approximately $18.8
million. 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.
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 to the gold consignor in
the case of merchandise sold pursuant to the Gold Consignment Agreement. Finlay
at times enters into futures contracts, such as options or forwards, based upon
the anticipated sales of gold product, 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. At
November 1, 1997, the gain/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 or October 31, 1998.
9
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - 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. The department operating
leases expire on various dates through 2003 and the office space and equipment
operating leases expire on various dates through 2008. All references herein to
leased departments refer to departments operated pursuant to license agreements
or other arrangements with host department stores.
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, although the depreciation schedule
provided for in the lease may differ from that used for financial reporting
purposes. The values of such fixed assets are 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 (unaudited):
<TABLE>
<CAPTION>
Thirteen Weeks Ended Thirty-Nine Weeks Ended
-------------------------- ---------------------------
November 1, October 31, November 1, October 31,
1997 1998 1997 1998
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Minimum fees................... $ 1,935 $ 5,911 $ 5,745 $ 15,567
Contingent fees................ 22,201 21,248 63,906 66,499
----------- ----------- ------------ -----------
Total........................ $ 24,136 $ 27,159 $ 69,651 $ 82,066
=========== =========== ============ ===========
</TABLE>
NOTE 5 - STOCKHOLDERS' EQUITY
On March 5, 1997, an executive officer of the Company received options
under the Company's Long Term Incentive Plan (the "1993 Plan") to purchase an
aggregate of 139,719 shares of Common Stock at an exercise price of $14.00 per
share. Such options vest and become exercisable on January 2, 2001.
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. The Board of
Directors adopted an amendment to the 1997 Plan, which was approved by the
Company's stockholders in June 1998, pursuant to which options available for
issuance under the 1997 Plan were increased to 850,000. Of the 850,000 shares of
the Company's Common Stock that have been reserved for issuance pursuant to the
1997 Plan, a total of 481,915 shares, as of October 31, 1998, are subject to
options granted to certain senior management, key employees and directors. The
exercise prices of such options range from $13.875 per share to $24.313 per
share.
10
<PAGE>
FINLAY ENTERPRISES,
INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - STOCKHOLDERS' EQUITY (continued)
Upon the commencement of his employment, an executive 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.
Pursuant to the terms of the note, the amount of the note has historically been
reflected as a reduction to equity and reflected in the Company's Consolidated
Balance Sheets as Note receivable from stock sale. On April 24, 1998, the
executive officer sold 100,000 of the Purchased Shares and repaid the note
("Note Receivable Repayment").
On December 1, 1998, the Compensation Committee of the Board of Directors
of the Company approved the repricing of 292,103 of the Company's outstanding
stock options at an exercise price of $8.25, which excludes stock options
previously granted to certain senior executives and members of the Board of
Directors. Shares acquired upon the excercise of such repriced options may not
be sold for a period of one year. On December 1, 1998, 60,000 stock options were
granted to three senior executives at an exercise price of $8.25. Such options
vest over a period of three years, in the second and third years.
NOTE 6 - OTHER TRANSACTIONS
On April 24, 1998, the Company completed a public offering of 1,800,000
shares of its Common Stock at a price of $27.50 per share (the "Equity
Offering"), of which 567,310 shares were sold by the Company and 1,232,690
shares were sold by certain selling stockholders. Concurrently with the Equity
Offering, the Company and Finlay Jewelry completed the public offering of $75.0
million aggregate principal amount of 9% Senior Debentures due May 1, 2008 (the
"Senior Debentures") and $150.0 million aggregate principal amount of 8-3/8%
Senior Notes due May 1, 2008 (the "Senior Notes"), respectively. In addition, on
April 24, 1998, the existing revolving credit agreement (the "Revolving Credit
Agreement") was amended to increase the line of credit thereunder to $275.0
million and to make certain other changes.
On May 1, 1998, the Company prepaid all of the $39.0 million of accreted
interest on the Company's 12% Senior Discount Debentures due 2005 (the "Old
Debentures") as of such date, in accordance with the indenture relating to the
Debentures (the 'Old Debenture Indenture"). The Company exercised its option to
prepay 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.
On May 26, 1998, the net proceeds to the Company from the Equity Offering,
the sale of the Senior Debentures, the Note Receivable Repayment and the
repayment of approximately $1.0 million of an intercompany liability by Finlay
Jewelry (the "Intercompany Repayment") were used to redeem the Company's Old
Debentures, including associated premiums. Also, on May 26, 1998, Finlay Jewelry
used the net proceeds from the sale of the Senior Notes to redeem Finlay
Jewelry's 10-5/8% Senior Notes due 2003 (the "Old Notes"), including associated
premiums, and to make the Intercompany Repayment. The above transactions,
excluding the Equity Offering, are referred to herein as the "Refinancing". The
Company recorded, in the second quarter, a pre-tax extraordinary charge of
approximately $12.2 million, including $7.1 million for redemption premiums and
approximately $3.9 million to write off deferred
11
<PAGE>
FINLAY ENTERPRISES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - OTHER TRANSACTIONS (continued)
financing costs and debt discount associated with the Old Debentures and the Old
Notes. As a result of certain call requirements associated with the Old
Debentures and the Old Notes, the debt could not be repaid until May 26, 1998.
Thus, for twenty-five days in the second quarter, Finlay was required to
maintain as outstanding both the new debt issued on April 24, 1998 as well as
the old debt retired on May 26, 1998. The net effect of carrying the new and old
debt, offset by reduced interest expense on the Company's revolving credit
facility and interest income on excess cash balances, was an increase to
interest expense of $0.7 million.
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 departments, for approximately $63.0 million. By acquiring
Diamond Park (the "Diamond Park Acquisition"), Finlay added 139 departments that
had total sales of approximately $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. Finlay financed the Diamond Park
Acquisition with borrowings under the Revolving Credit Agreement.
NOTE 7 - UNAUDITED PRO FORMA FINANCIAL INFORMATION
The following table presents the calculation of pro forma earnings per
share data for the thirty-nine weeks ended October 31, 1998. The pro forma
consolidated financial information excludes the extraordinary charge of $12.2
million, on a pre-tax basis, including $7.1 million for redemption premiums and
approximately $3.9 million to write off deferred financing and debt discount
costs associated with the Old Debentures and the Old Notes. The income tax
benefit on the extraordinary charges totaled $4.8 million. In addition, the pro
forma consolidated financial information excludes the nonrecurring interest
associated with refinancing of $ 0.7 million, on a pre-tax basis, as a result of
certain call requirements on the debt retired.
In thousands, except share and
per share amounts
<TABLE>
<CAPTION>
Thirty-Nine
Weeks Ended
October 31,
1998
------------
<S> <C>
Net income (loss) per Consolidated Statements of Operations.. $ (17,185)
Add: Extraordinary charges from early extinguishment of
debt, net of income tax benefit........................ 7,415
Add: Nonrecurring interest associated with refinancing,
net of income tax benefit.............................. 400
-------------
Pro Forma net income (loss).................................. $ (9,370)
=============
Pro Forma net income (loss) per share applicable to
common shares:
Basic net income (loss) per share......................... $ (0.92)
=============
Diluted net income (loss) per share....................... $ (0.92)
=============
Weighted average shares and share equivalents outstanding.... 10,171,712
=============
</TABLE>
12
<PAGE>
PART I - FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations
The following table sets forth operating results as a percentage of sales
for the periods indicated:
Statements of Operations Data
(unaudited)
<TABLE>
<CAPTION>
Thirteen Weeks Ended Thirty-Nine Weeks Ended
------------------------- -------------------------
November 1, October 31, November 1, October 31,
1997 1998 1997 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales............................................ 100.0% 100.0% 100.0% 100.0%
Cost of sales.................................... 48.2 49.0 48.6 48.9
----------- ----------- ----------- -----------
Gross margin.................................. 51.8 51.0 51.4 51.1
Selling, general and administrative expenses..... 47.1 47.6 46.7 46.8
Depreciation and amortization.................... 2.0 2.3 2.0 2.3
----------- ----------- ----------- -----------
Income (loss) from operations................. 2.7 1.1 2.7 2.0
Interest expense, net............................ 6.2 4.9 5.9 5.0
Nonrecurring interest associated with refinancing - - - 0.1
----------- ----------- ----------- -----------
Income (loss) before income taxes and
extraordinary charges....................... (3.5) (3.8) (3.2) (3.1)
Provision (credit) for income taxes.............. (1.3) (1.5) (1.1) (1.2)
----------- ----------- ----------- -----------
Income (loss) before extraordinary charges.... (2.2) (2.3) (2.1) (1.9)
Extraordinary charges from early extinguishment
of debt, net of income tax benefit.......... - - - 1.5
----------- ----------- ----------- -----------
Net income (loss)............................. (2.2)% (2.3)% (2.1)% (3.4)%
=========== =========== =========== ===========
</TABLE>
Thirteen Weeks Ended October 31, 1998 Compared with Thirteen Weeks Ended
November 1, 1997
Sales. Sales for the thirteen weeks ended October 31, 1998 increased $17.1
million, or 11.5%, over the comparable period in 1997. Consolidated comparable
department sales (departments open for the same months during comparable
periods) increased 0.9% and domestic comparable department sales increased 1.8%.
During the third quarter of 1998, Sonab, the Company's French subsidiary,
continued to experience lower sales trends due to the transition from a
promotional pricing strategy to an everyday low price strategy. This change was
made as a result of Sonab reassessing its pricing policy following certain local
French court decisions and the adverse impact of such change is expected to
continue at least until mid-1999. Sales from the operation of net new
departments (departments not included in comparable department sales)
contributed $15.8 million, which included $14.4 million from the former Diamond
Park departments. During the thirteen weeks ended October 31, 1998, Finlay
opened nine departments and closed eight departments. The openings and closings
were all within existing store groups. As a result of Dillard's purchase of
Mercantile Stores in August 1998 and the subsequent sale of 31 of these stores
to other Finlay host department stores, department openings in such stores are
considered to be replacement stores and are excluded from the openings and
closings above.
Gross margin. Gross margin for the period increased by $7.6 million,
primarily as a result of the sales increase. As a percentage of sales, gross
margin decreased by 0.8%, which is primarily attributed
13
<PAGE>
to (i) a $0.5 million lower LIFO benefit in the 1998 period versus the 1997
period, (ii) lower gross margins experienced by the former Diamond Park
departments, particularly as the merchandise acquired as part of the Diamond
Park Acquisition continues to be sold and (iii) management's efforts to increase
market penetration and market share through its competitive pricing strategy.
Selling, general and administrative expenses. Selling, general and
administrative expenses ("SG&A") increased $8.8 million, or 12.6%, due primarily
to payroll expense and lease fees associated with the increase in the Company's
sales. In addition, the favorable leveraging of SG&A that the Company has
experienced in past quarters has been adversely impacted by the slowdown of
sales, particularly in Europe, and expenses relating to the Company's Year 2000
remediation project, which totaled approximately $0.9 million. As a result of
these factors, SG&A as a percentage of sales increased by 0.5%.
Depreciation and amortization. Depreciation and amortization increased by
$0.9 million, reflecting an increase in capital expenditures for the most recent
twelve months, depreciation on Finlay's new central distribution facility and
amortization related to the Diamond Park Acquisition, offset by the effect of
certain assets becoming fully depreciated. The increase in fixed assets was due
to the addition of new departments, including the former Diamond Park
departments, and the renovation of existing departments.
Interest expense, net. Interest expense decreased by $1.0 million
reflecting a lower weighted average interest rate (8.1% for the 1998 period
compared to 9.8% for the comparable period in 1997) relating to the lower
interest rates on the Senior Debentures and the Senior Notes as compared to the
Old Debentures and the Old Notes offset by an increase in average borrowings
($375.0 million for the period in 1998 compared to $355.8 million for the
comparable period in 1997). The increase in average borrowings is primarily a
result of additional indebtedness outstanding under the Revolving Credit
Agreement.
Provision (credit) for income taxes. The income tax provision for the 1998
and 1997 periods reflects effective tax rates of 40.5% and 41.5%, respectively.
Net income (loss). The net loss of $3.9 million for the 1998 period was
$0.6 million higher than the net loss of $3.3 million for the comparable period
as a result of the factors discussed above.
Thirty-Nine Weeks Ended October 31, 1998 Compared with Thirty-Nine Weeks Ended
November 1, 1997
Sales. Sales for the thirty-nine weeks ended October 31, 1998 increased
$72.8 million, or 16.9%, over the comparable period in 1997. Consolidated
comparable department sales increased 2.3% and domestic comparable department
sales increased 3.4%. Management attributes this increase in comparable
department sales to the following Company initiatives: (i) emphasizing 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) continuing project PRISM (Promptly Reduce Inefficiencies and
Sales Multiply), a program designed to allow Finlay's sales associates more time
for customer sales and service. During the third quarter of 1998, Sonab
continued to experience lower sales trends due to the transition from a
promotional pricing strategy to an everyday low price strategy. This change was
made as a result of Sonab reassessing its pricing policy following certain local
French court decisions and the adverse impact of such change is
14
<PAGE>
expected to continue at least until mid-1999. Sales from the operation of net
new departments contributed $62.9 million, which included $60.4 million from the
former Diamond Park departments. During the thirty-nine weeks ended October 31,
1998, Finlay opened 31 departments and closed 35 departments. The openings were
all within existing store groups, with the exception of two departments opened
in new store groups in the United Kingdom. The closings included all five
departments in Dillard's and all seven departments in Debenhams, with the
remaining 23 departments closed within existing store groups. As a result of
Dillard's purchase of Mercantile Stores in August 1998 and the subsequent sale
of 31 of these stores to other Finlay host department stores, department
openings in such stores are considered to be replacement stores and are excluded
from the openings and closings above.
Gross margin. Gross margin for the period increased by $35.7 million,
primarily as a result of the sales increase. As a percentage of sales, gross
margin decreased by 0.3%, which is primarily attributed to (i) lower gross
margins experienced by the former Diamond Park departments, particularly as the
merchandise acquired as part of the Diamond Park Acquisition continues to be
sold and (ii) management's efforts to increase market penetration and market
share through its "Key Item" and "Best Value" programs, which produce higher
sales volume and a slightly lower gross margin, on average, than other
merchandise.
Selling, general and administrative expenses. SG&A increased $34.2 million,
or 17.0%, due primarily to payroll expense and lease fees associated with the
increase in the Company's sales. In addition, the Company experienced higher
than anticipated expenses relating to the central distribution facility,
increased medical expenses associated with the implementation of a new medical
benefit plan and expenses relating to the Company's Year 2000 remediation
project, which totaled approximately $0.9 million, offset by lower advertising
expenditures as a percentage of sales. As a result of these factors, SG&A as a
percentage of sales increased by 0.1%.
Depreciation and amortization. Depreciation and amortization increased by
$2.9 million, reflecting an increase in capital expenditures for the most recent
twelve months, depreciation on Finlay's new central distribution facility and
amortization related to the Diamond Park Acquisition, offset by the effect of
certain assets becoming fully depreciated. The increase in fixed assets was due
to the addition of new departments, including the former Diamond Park
departments and the renovation of existing departments.
Interest expense, net. Interest expense decreased by $0.1 million
reflecting a lower weighted average interest rate (8.8% for the 1998 period
compared to 10.0% for the comparable period in 1997) relating to the lower
interest rates on the Senior Debentures and the Senior Notes as compared to the
Old Debentures and the Old Notes offset by an increase in average borrowings
($360.7 million for the period in 1998 compared to $325.9 million for the
comparable period in 1997). The increase in average borrowings is a result of an
increase in the outstanding balance of the Old Debentures due to the accretion
of interest and additional indebtedness outstanding under the Revolving Credit
Agreement (adjusted to exclude the timing impact of the call requirements on the
Old Debentures and the Old Notes, discussed below).
Nonrecurring interest associated with refinancing. As a result of certain
call requirements associated with the Old Debentures and the Old Notes, the debt
could not be repaid until May 26, 1998. Thus, for twenty-five days in the second
quarter, Finlay was required to maintain as outstanding both the new debt issued
on April 24, 1998 as well as the old debt retired on May 26, 1998. The net
effect of carrying the new and old debt, offset by reduced interest expense on
the Company's revolving credit
15
<PAGE>
facility and interest income on excess cash balances, was an increase to
interest expense of $0.7 million, on a pre-tax basis.
Provision (credit) for income taxes. The income tax provision for the 1998
and 1997 periods reflects effective tax rates of 40.5% and 41.5%, respectively.
Extraordinary charges from early extinguishment of debt, net of income tax
benefit. In conjunction with the repayment of the Old Debentures and the Old
Notes, the Company recorded a pre-tax extraordinary charge of $12.2 million,
including $7.1 million for redemption premiums and approximately $3.9 million to
write off deferred financing and debt discount costs associated with the Old
Debentures and the Old Notes. The income tax benefit on the extraordinary
charges totaled $4.8 million.
Net income (loss). The net loss of $17.2 million for the 1998 period was
$8.3 million higher than the net loss of $8.9 million for the comparable period
as a result of the factors discussed above.
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 and information technology investments. For the thirty-nine
weeks ended November 1, 1997 and October 31, 1998, capital expenditures totaled
$15.3 million and $11.7 million, respectively. For 1997, capital expenditures
totaled $19.3 million, which included construction costs related to the
Company's central distribution 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 $122.2 million at October
31, 1998, an increase of $13.8 million from January 31, 1998. The increase
resulted primarily from the recording of an income tax receivable relating to
the prepayment of accreted interest on the Company's Old Debentures, the net
proceeds to the Company from the Equity Offering and the sale of the Senior
Debentures and the Senior Notes, partially offset by the use of such proceeds to
prepay the Old Debentures and the Old Notes, the impact of the interim net loss
exclusive of depreciation and amortization 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, November and December in
anticipation of the year-end holiday season. Accordingly, Finlay experiences
seasonal cash needs as inventory levels peak. The Revolving Credit Agreement
provides Finlay with a line of credit of up to $275.0 million to finance
seasonal cash and other working capital needs. 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
Agreement) plus 0.5% or (ii) adjusted LIBOR plus 1.5%. Commencing in late
December 1998, amounts outstanding under the Revolving Credit Agreement will
bear interest at a rate equal to, at Finlay's option,
16
<PAGE>
(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"). The indentures
relating to the Senior Debentures and the Senior Notes do not have a balance
reduction requirement. Borrowings under the Revolving Credit Agreement at
October 31, 1998 were $150.1 million, compared to a zero balance at January 31,
1998 and $170.2 million at November 1, 1997. The average amounts outstanding
under the Revolving Credit Agreement were $110.2 million and $131.4 million
(adjusted for the impact of the temporary paydown of the revolving credit
facility due to certain call requirements associated with the Old Debentures and
the Old Notes) for the thirty-nine weeks ended November 1, 1997 and October 31,
1998, respectively. The maximum amount outstanding for the thirty-nine weeks
ended October 31, 1998 was $162.9 million.
Significant additional working capital has not been required with respect
to the operation of the former Diamond Park departments because Finlay purchased
the inventory of those Diamond Park departments which it acquired. Inventory
purchases for the former Diamond Park departments has been and will continue to
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
working capital requirements for the former Diamond Park departments have been
and will continue to be reduced as compared to the amount of working capital
required at the time of the Diamond Park Acquisition.
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. For 1997, Finlay had an average
balance of consignment merchandise of $216.5 million from over 200 vendors as
compared to an average balance of $201.8 million in 1996. As of October 31,
1998, $315.7 million of consignment merchandise was on hand as compared to
$219.8 million at January 31, 1998 and $237.7 million at November 1, 1997.
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 Old
Notes and amounts due under the Revolving Credit Agreement, including the
payments required pursuant to the Balance Reduction Requirement and, as a result
of the completion of the Equity Offering and Refinancing, the Senior Debentures
and the Senior Notes. As of October 31, 1998, Finlay's outstanding borrowings
were $375.1 million, which included a $75.0 million balance under the Senior
Debentures, a $150.0 million balance under the Senior Notes and a $150.1 million
balance under the Revolving Credit Agreement. On May 1, 1998, the Company
prepaid in accordance with the Old Debenture Indenture, all of the $39.0 million
of accreted interest on the Old Debentures as of such date. The Company
exercised its option to prepay 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, on May 26, 1998, the
Company redeemed the outstanding principal amounts, including associated
premiums, of the Old Debentures and the Old Notes. Finlay funded the prepayment
and the redemptions using the proceeds from the sale of the Senior Debentures,
the Equity Offering and the sale of the Senior Notes, together with other
available funds. In connection with the redemption of the Old Debentures and the
Old Notes, the Company recorded, in the second quarter, a pre-tax nonrecurring
charge of approximately $12.2 million, including $7.1 million for
17
<PAGE>
redemption premiums and approximately $3.9 million to write off deferred
financing and debt discount costs associated with the Old Debentures and the Old
Notes.
Finlay Jewelry is party to the Gold Consignment Agreement, which expires on
December 31, 2001. 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) $32.0 million worth of
gold, subject to a formula as prescribed by the Gold Consignment Agreement. At
October 31, 1998, amounts outstanding under the Gold Consignment Agreement
totaled 64,313 fine troy ounces, valued at approximately $18.8 million. The
average amount outstanding under the Gold Consignment Agreement was $14.3
million in 1997.
"Year 2000" computer software and hardware failures of internal systems
and/or third party systems could have a significant, adverse impact on all
aspects of the Company's operations. The Company recognizes the need to ensure
that its operations and its relationship with its host stores, vendors and other
third parties will not be adversely affected. Consequently, a comprehensive plan
is being executed to ensure that all systems critical to the operation of the
Company are Year 2000 compliant.
The Year 2000 plan incorporates various information technology systems,
including the Company's core business systems, end user systems, non-information
technology systems and significant third party systems. The plan is structured
into five primary phases: identification, assessment, remediation, testing and
implementation. In addition, management recognizes the importance of developing
a contingency plan in the event of a Year 2000 failure, the development of which
is in progress. The Company has completed the identification and assessment
phases of all critical components and is in the remediation phase. The Company
expects that all internal systems, including its non-information technology
systems, will be Year 2000 compliant by August 1999. In addition, Finlay has
communicated, and will continue to communicate, with all of its host stores,
vendors and other third parties to obtain Year 2000 compliance certification.
Progress reports on the Year 2000 project are presented regularly to senior
management and the Company's Board of Directors.
Finlay is using, and will continue to use, a combination of internal and
external resources. The Company has estimated that the direct costs related to
its Year 2000 efforts total approximately $4.0 million, of which approximately
$0.9 million has been recorded in the third quarter. Finlay expects to incur the
balance of these costs during 1998 and through 1999 and expects to fund such
costs through operating cash flows.
The consequences of a disruption of the Company's operations, whether
caused by the Company's internal systems or those of any significant third
party, could have a material adverse effect on the Company's financial position
or results of operations. The likely worst case scenario may be an inability to
distribute merchandise to its departments and to process its daily business for
some period of time. The lost revenues, if any, resulting from a worst case
scenario would depend on the time period in which the failure goes uncorrected
and the difficulty to remediate such failure. There can be no assurances that
Finlay will not experience significant cost overruns or delays in addressing
this issue.
The Company is in the process of implementing several information
technology initiatives, including the design and development of a new
merchandising system and the upgrade of point-of-sale systems and related
hardware in the majority of Finlay's departments. These projects will serve to
support future growth of the Company as well as provide improved analysis and
reporting capabilities. The cost associated with these projects is estimated to
be $11.0 million for software and implementation costs, to
18
<PAGE>
be included in Deferred charges and other assets, and approximately $3.0 million
for hardware and related equipment, to be included as a component of the
Company's capital expenditures and reflected in Fixed assets.
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 certain recapitalization
transactions in 1993, 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 existed 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 sale of shares of Common Stock of the Company in 1997. 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.
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 and the thirty-nine
weeks ended October 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 or at October 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.
Finlay believes that, based upon current operations, anticipated growth,
and 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.
Currently, Finlay Jewelry's principal financing arrangements restrict annual
distributions from Finlay Jewelry to the Company to 0.25% of Finlay Jewelry's
net sales for the preceding fiscal year and also allow distributions to the
Company to enable it to make interest payments on the Senior Debentures. The
amounts required to satisfy the aggregate of Finlay's interest expense and
required amortization payments totaled $13.0 million and $15.7 million for the
thirty-nine weeks ended November 1, 1997 and October 31, 1998, 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
19
<PAGE>
any of the first three quarters of any given fiscal year, taken individually or
in the aggregate, are not indicative of annual results.
Inflation
The effect of inflation on Finlay's results of operations has not been
material in the periods discussed.
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1993 and Section 21E
of the Securities Exchange Act of 1934 (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 in the United States and France, 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 estimate of the cost to address Year 2000 compliance issues and the
impact on the Company's operations of a Year 2000 failure, 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 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 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
the date hereof. The Company undertakes no obligation to publicly revise these
forward-looking statements to reflect events or circumstances that arise after
the date hereof. 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.
20
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
2 Not applicable.
3 Not applicable.
4 Not applicable.
10 Not applicable.
11 Not applicable.
15 Not applicable.
18 Not applicable.
19 Not applicable.
22 Not applicable.
23 Not applicable.
24 Not applicable.
27 Financial Data Schedule.
99 Not applicable.
B. Reports on Form 8-K
None
21
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: December 11, 1998 FINLAY ENTERPRISES, INC.
By:/s/ Barry D. Scheckner
-------------------------------------
Barry D. Scheckner, Senior Vice
President and Chief Financial Officer
(As both a duly authorized officer of
Registrant and as principal financial
officer of Registrant)
22
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINLAY
ENTERPRISES, INC. FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-30-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> OCT-31-1998
<CASH> 3,434
<SECURITIES> 0
<RECEIVABLES> 36,750
<ALLOWANCES> 0
<INVENTORY> 325,756
<CURRENT-ASSETS> 405,372
<PP&E> 106,869
<DEPRECIATION> 36,399
<TOTAL-ASSETS> 592,165
<CURRENT-LIABILITIES> 283,157
<BONDS> 225,000
0
0
<COMMON> 104
<OTHER-SE> 74,831
<TOTAL-LIABILITY-AND-EQUITY> 592,165
<SALES> 504,252
<TOTAL-REVENUES> 504,252
<CGS> 246,620
<TOTAL-COSTS> 246,620
<OTHER-EXPENSES> 247,491
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 25,838
<INCOME-PRETAX> (15,697)
<INCOME-TAX> (5,927)
<INCOME-CONTINUING> (9,770)
<DISCONTINUED> 0
<EXTRAORDINARY> 7,415
<CHANGES> 0
<NET-INCOME> (17,185)
<EPS-PRIMARY> (1.69)
<EPS-DILUTED> (1.69)
</TABLE>
