IDEX Online Research: Finlay Facing Double-Barrel Challenges

Like virtually every other mass market jeweler, Finlay Enterprises reported a larger seasonal loss in the third quarter ended October, 2005.  In addition, now that Federated has taken over May Department Stores Company, Finlay is facing the prospect of closing roughly 200 of its 1,000 units.  Finlay operates leased jewelry departments in most of the major U.S. department stores.  The following table summarizes the company’s financial results for the three-month period ended October, 2005. 

Highlights of the quarter’s performance include the following factors.  Other jewelers and suppliers, especially those which operate in the fashion jewelry segment, can use these results to benchmark performance.

• Sales – Total sales +9.8 percent; same-store sales +1.3 percent.  Total sales would have been up 0.4 percent, if sales from the recently acquired Carlyle stores are eliminated. 
• Sales were strongest in the Bloomingdale’s and Parisian units.
• Strong product categories included the following:
• Diamond bracelets
• Diamond hoop earrings
• Three-stone jewelry
• Yellow gold
• Right-hand rings
• Diamond stud earrings
• Silver with semi-precious and diamond stones
• Big, bold colored stones
• Moissanite
• Gross margin – 49.4 percent vs 50.7 percent -- Four? factors had an impact on Finlay’s gross margin:
• Higher gold prices hurt.
• A higher mix of clearance sales had a negative impact on margins.
• The gross margin in the Carlyle division hurt, since Carlyle operates with an inherently lower margin.
• The LIFO reserve (reflecting inflation) was about flat with last year. 
• Operating costs – 49.1 percent vs 49.5 percent -- Several factors helped bring Finlay’s operating cost ratio down.
• Even though same-store sales were up only modestly, they provided some leverage of costs.
• Carlyle operates with an inherently lower operating cost structure.
• Other costs – The company has begun accruing unit closing costs related to exiting the 200 units in 2006.  Interest costs were higher due to higher interest rates and larger borrowing levels.
• Bottom-line profits (loss) – While the company’s operating cost ratio fell, its gross margin fell at a notably greater rate.  Further, Finlay booked some unusual costs in the quarter; these, too, had a negative impact on profitability.  Overall, the company’s net after-tax loss was nearly $6.9 million, substantially worse than last year’s $4.8 million loss. 
• Other – Consignment inventory in the Finlay leased department units was about 53 percent of total inventory. 
• Store units – Despite the pending closure of about 200 units by mid-2006, Finlay continues to open leased units and has signed other deals securing existing doors. 
• In the fourth quarter, the company will open four new units – three in Bon-Ton and one in a Belk unit.  Two Carlyle units will be closed; they have already been replaced by new stores.  At year-end, we expect that 1,110 units will be operating. 
• Next year, Finlay plans to open leased departments in Dillard’s, Belk, and Bloomingdale’s.  At least one new Carlyle store should open. 
• Finlay recently signed a deal with Federated to operate 315 of its 404 doors through January 2009.  The new deal also removed Finlay’s non-compete clause.
• It is likely that Finlay will seek to acquire other chains, similar to Carlyle, now that the non-compete clause has been removed from some of its leased deals with Federated. 
• Longer term outlook – With the scheduled closing of about 200 units between now and mid-2006, Finlay will face a 20 percent reduction in its door count.  For the most part, costs associated with these units are variable.  However, there will likely be some cost reductions in the corporate structure.  The closings will generate cash flow for Finlay.  Management has indicated that it would not likely use this cash to pay a dividend or buy back stock.  Our sense is that they will add it to their war chest for possible acquisitions.  There are few opportunities for leased departments currently available in U.S. retailers.  It is unlikely that Finlay would be acquired by someone else.