Finlay posted extremely weak results for its first quarter ended April 2009, when all of the unusual costs and revenues are excluded. While sales were up a reported 12 percent, it was all due to low-margin liquidation transactions in the leased department business. Sales in the specialty jewelry division – stand-alone jewelry stores – were down 20 percent, and we’d estimate that adjusted sales – excluding liquidation revenues – in the leased department units were down 10-15 percent.

 

Finlay lost nearly $29 million in the quarter, versus a loss of $11 million in the prior year. The losses would have been higher, except that high liquidation sales helped absorb some relatively fixed costs, and accounting adjustments related to inventory valuation helped reduce operating costs.

 

Further, its key lenders have declared that Finlay’s debt is in default, and they are awaiting the sale of assets – inventory and operating divisions – to get their money back.

 

The key question on everyone’s mind is this: what is going to happen to Finlay? If the company follows through with its strategic plan, it will be out of the leased department business, and it will try to move ahead with its better-end specialty jewelry stores – Carlyle, Congress and Bailey Banks & Biddle. While this seems to be a relatively simple strategy, the recessionary environment has been the wild card. Typically, retailers which have tried to downsize in order to survive don’t last very long. Bankruptcy is a possibility for Finlay, but there are some technical reasons that have precluded the company from filing, so far.

 

We are not going to make a prediction, but this much is clear: Finlay is struggling, and the odds don’t appear to be in its favor.

 

The table below summarizes the company’s key financial results for its first fiscal quarter ended April 2009.

Background

Earlier this year, Finlay announced a two-prong strategic realignment of its business:

 

• It plans to exit the leased department business, which has been its core business since the 1960s. Leased departments, also referred to as licensed departments, are essentially a store-within-a-store: Finlay employed the people, paid rent, incurred advertising expense, while taking advantage of the customer traffic which came into the host stores – all major U.S. department stores. The typical Finlay leased jewelry department has about 80 linear feet of display (a range of 50-150 feet), and generates an average ticket of $270. At their peak in the late 1990s and early 2000s, each leased department unit generated about $960,000 per unit, about in line with the typical specialty jewelry store average revenues at that time. In short, run correctly, these leased department units should be highly profitable.
  
  The leased jewelry department business has been shrinking for several years. At its peak around 2000-2001, Finlay operated over 1,000 leased department units in major department stores across the U.S. At the end of the most recent fiscal year ended January 2009, the company operated only 566 leased departments; at the end of the first quarter, there were only about 369 units still operating.

• It plans to close roughly half of its specialty jewelry stores. Currently, it operates about 107 specialty stand-alone jewelry stores, a number which has been consistent for the past couple of years: 68 Bailey Banks & Biddle (BBB) units, five Congress stores, and 34 Carlyle units. It acquired BBB in November 2007 with 69 stores; it bought Congress in November 2006 with five stores; and, it purchased the Carlyle chain in May 2005 with 32 stores.

Finlay Jewelry was originally incorporated in 1985 to operate leased jewelry department stores, though predecessor companies have leased jewelry department relationships back to 1969 (Gottchalks), as well as Carson Pirie Scott / Bergner’s / Boston Store / Younkers / Herberger’s in 1977, Lord & Taylor (1978), and Macy’s (1983). Technically, Finlay Jewelry is a subsidiary of Finlay Enterprises; its recent acquisitions are either wholly-owned subsidiaries of Finlay Jewelry or, in the case of BBB, an unincorporated division of Finlay Jewelry. Finlay Enterprises is solely a holding company. This structure, while seemingly complex, will allow for its strategic realignment to be implemented with a minimum of disruption of the company.

 

First Quarter Highlights

• Total sales were $159.3 million for the 13-week period ended April 2009, up 12 percent from the prior year’s sales of $142.1 million.

• Sales in the specialty jewelry division – BBB, Congress and Carlyle – were $62.5 million, down about 20 percent from the prior year. The specialty jewelry units are all “better-end” stores, a segment which is suffering worse in the current recessionary environment.

• Sales in the leased department units – a business that Finlay is exiting – were $96.9 million, up about 50 percent from the prior year. Inventory liquidation sales at very low margins fueled this dramatic increase in revenues.

• The table below summarizes performance by operating division for Finlay in the first fiscal quarter ended April 2009.

• Finlay’s first quarter gross margin fell to 41.2 percent from 43.6 percent last year due to lower margins in the leased department stores related to inventory liquidation sales. There was an offset to these liquidation margins: the LIFO method of accounting helped boost these margins. If the impact of LIFO is eliminated, Finlay’s gross margin in the quarter would have been about 31 percent.

• The company’s operating expense ratio decreased to 48.1 percent from the prior year’s 48.7 percent due primarily to higher sales in the leased department business which helped absorb relatively fixed overhead costs. The operating expense ratio would have been even lower, excluding one-time severance costs ($1.6 million) and consulting expenses related to restructuring ($2.5 million). Without these unusual costs, Finlay’s operating expense ratio would have been about 45.5 percent or so.

• The loss from operations in the stand-alone specialty jewelry stores was $12.1 million in the first quarter, up dramatically from last year’s first quarter loss of $1.3 million in this division. Unfortunately, this division operates with high fixed costs. Thus, a 20 percent decline in sales had a dramatic impact on bottom-line profits.

• Currently, Finlay is in default with its current sources of financing, so the sale of one or more divisions – coupled with liquidation of inventory in the leased departments – is a top priority of the company, as it attempts to raise capital for continuing operations.

• Finlay’s net worth dropped into negative territory for the first time since we have been tracking its financials – nearly two decades. The company had negative net worth of just under $22 million at the end of the first quarter. At its peak several years ago, Finlay had a net worth of almost $170 million. It has never had a net worth that was as high as a financial analyst might expect, primarily because it has relied on debt for most of its financing over the years.

• In the quarter ended April 2009, Finlay closed 194 of its leased departments. Thus, it would appear that the company operated only about 369 leased department units at the end of the quarter.