Despite losing nearly 20 percent of its 1,000 leased departments so far this year, with another 5 percent slated to close in the fourth quarter, Finlay Enterprises posted a solid sales gain from continuing operations, and the company reduced expenses for its third fiscal quarter ended October. However, its gross margin fell, and its pretax loss widened. The table below summarizes third quarter results from continuing operations.

 

Where Is Finlay Headed?

Finlay management hasn’t been sitting on its hands wondering what to do, now that its leased department business has suddenly shrunk. It has been on the acquisition trail. In 2005, it acquired the Carlyle Jewelers chain with 34 stores, which should add up to $100 million in sales next year. Earlier this fall, Finlay announced its intention to acquire Congress Jewelers in Florida. This four-store – soon to be five stores – chain could add another $30-40 million in sales for Finlay in 2007. Thus, even though Finlay has lost about $240 million in sales this year, it has already replaced nearly 60 percent of them with new stores.

 

Management’s expansion plan calls for acquiring guild jewelers for growth, though it continues to seek new leased department opportunities, with no success so far. Chairman Art Reiner says that the company’s future lies in the luxury jewelry business, saying that Finlay’s current business is best at Carlyle, a guild jeweler, and Bloomingdale’s which is an upscale department store chain. Thus, the guild-store Congress acquisition fits Finlay’s future direction.

 

Both Carlyle and Congress are more alike than different, as the following illustrates:

• Both have a similar customer base of high-end consumers
• Both have a similar vendor base, including the following brands:
• Rolex
• Tag Heuer
• Raymond Weil
• John Hardy
• Roberto Coin
• Congress has created a proprietary line of gold jewelry, called Sea Life, which could be rolled out to Carlyle and Bloomingdale’s
• Congress sales per store are somewhat higher at $5-6 million per unit than Carlyle’s sales per store at $3-3.5 million per unit.

Highlights from October Quarter

The following are highlights from Finlay’s October quarter financial results:

 

• Sales strong – Total sales for the quarter were $148.3 million, up 5.5 percent from last year (continuing operations); same-store sales were up a solid 4 percent. Total revenues, including discontinued operations, were down 19 percent.

• Hot merchandise – Diamonds led the way with solid gains in the October quarter. Finlay’s diamond mix has historically been below average, since it focused on fashion jewelry while generally ignoring the diamond-driven bridal market, since its department store hosts are best known for fashion-forward goods. Finlay’s diamond sales mix of 28 percent is far below the industry average of about 48 percent, and well below some guild jewelers who generate 60-70 percent of their sales from diamonds and diamond jewelry. Finlay’s average ticket of just over $200 is well below its major mass market competition’s average ticket of $300-400, reflecting the lack of big ticket diamond engagement ring sales.  . Specific categories that showed the largest sales gains in the third quarter included the following:
• Journey diamonds
• Diamond circles
• Certified diamonds in bracelets, studs, and crosses
• Right-hand rings
• Better silver with diamond and gemstone accents
• Designer silver, especially with a fashion look
• Better Swiss watches

• Holiday marketing to be aggressive – Finlay will utilize more television for much of its advertising this year, highlighting key items and luxury watches. In the final eight days prior to Christmas, the company’s advertising will be particularly aggressive.

• Financial results mixed – While its gross margin was down, its operating expense ratio also fell.

• Gross margin – 46.8 percent vs. 49 percent - A LIFO charge of $1.5 million (versus $200,000 last year) hurt the gross margin by 90 basis points. Further, higher gold prices which could not be passed through to retail via higher prices hurt by about 70 basis points. In addition, as Carlyle’s sales increase in importance, the company’s gross margin will decline since Carlyle’s gross margin is inherently lower due to its watch sales mix. Finally, due to a rising diamond sales mix, gross margins were down, since diamonds carry a lower gross margin.

• Operating cost ratio – 49 percent vs. 50.6 percent -- Staff reductions, lower advertising costs, and field expense reductions helped bring operating costs lower for Finlay.

• Pretax margin – (9.1 percent) vs. (8.8 percent) – The primary reason that the company’s pretax loss was wider related to the sharp decline in its gross margin. Both lower operating costs and lower interest costs offset the gross margin decline somewhat, but not enough for a favorable pretax margin comparison.

• Gold lease arrangement terminated – While gold lease arrangements can help reduce the cost of carrying gold inventory, they have a downside: when gold prices rise, especially if they rise sharply in a short period of time, a gold leasing arrangement can be painful. Most retailers no longer use gold lease financing, and it is no surprise that Finlay is exiting gold lease program. Management cited three reasons for abandoning gold leasing: 1) the company can better manage its gross margin by owning the gold; 2) it will smooth gold price fluctuations (in a gold lease program, gold is usually priced daily); and 3) it will eliminate an off-balance sheet contractual obligation.

• Closings and openings – Finlay will exit all of its Belk locations – 69 doors – at the end of January 2007. At fiscal year end (January 2007), Finlay is expected to operate about 756 doors, down from just over 1,000 a year ago. In 2007, one new Carlyle unit will open; another Carlyle unit is slated to open in early 2008, with the possibility of one or two more Carlyle units in 2008. Finlay continues to seek acquisitions, especially among luxury jewelers in the U.S.