IDEX Online Research: Finlay Transition Continues
March 26, 07
Finlay Chairman Art Reiner said, “We consider 2006 and 2007 to be a transitional period for our company, as we absorb the impact of store closures and expand our presence in the specialty jeweler store sector. Although the department store sector remains an important component in our core business, we have taken important steps to diversify our revenue streams which have been bolstered by the solid performances at Carlyle and the newly acquired Congress Jewelers, as well as our positive results in the luxury sector, including Bloomingdales.”
If that sounds like public relations rhetoric, it isn’t. It really summarizes where Finlay is today, and it signals the path to the future.
In the course of two years, Finlay has closed roughly 300 of its 1,000 leased departments, mostly as a result of the merger of Federated and May department store chains. Think about it. What if you lost about 30 percent of your sales in a short period? While Finlay has posted an operating loss for the past two years and expects to lose money again in 2007, the operating losses are not dramatic. In short, Finlay has successfully managed its sharp decline in business masterfully, if not profitably.
Finlay’s Reiner says that its leased department operation remains core to Finlay’s business; at 83 percent of corporate revenues, it certainly is a core component. But the problem with operating leased departments: your destiny is further beyond your control than in just about any other kind of business. Your host store tells you when to open and close; your host store tells you how much you owe for their advertising; your host store tells you just about everything about how to run your business, but they don’t take the business risk.
Reiner says Finlay continues to look at leased department opportunities, but they must be profitable for the company. No wonder he hasn’t added any new leased departments yet. It is tough to generate significant profits with leased departments. Across retailing, leased department operations are going the way of high-button shoes and buggy whips; it is tough to make money in the leased department business.
Reiner did indicate that the company was in preliminary discussions with two entities, but he said he had no news to report about the status of these talks. We’ve heard that before, and nothing has materialized. We’re not surprised.
Finlay management is focused on developing new business opportunities beyond the leased department operations. While it was closing department store doors, it has been on the street seeking acquisitions. They have been slow to come, with only two in the past three years. But those acquisitions are important: they will generate $130-140 million in sales in 2007, or roughly 17 percent of the company’s projected revenues.
If you roll revenues from Congress, Carlyle, and Bloomingdale’s business into a single category – guild jewelry – sales will be about $250 million in 2007. That’s nearly one-third of Finlay’s business, and it appears to generate a significant portion of the company’s profit.
In our opinion, Finlay will continue to focus on acquiring look-alikes to Congress and Carlyle, more guild jewelers.
Highlights from the company’s fourth quarter and full year results from continuing operations follow. All of these results relate to “continuing operations”, unless otherwise noted. Accounting for “continuing operations” differs materially from accounting for “discontinued operations.”
For example, when a business segment is discontinued, unused reserves may add to profit and one-time expenses may add to costs. The bottom line is that financial results from discontinued operations do not reflect the financial health of a company. Indeed, many jewelers claim that they make more money from GOB (Going Out of Business) sales than any other type of sale. It’s all in the accounting.
 Source: Company reports |
We also note that Finlay’s fiscal year ended January 2007 included 53 weeks of results versus 52 weeks for the prior year. In our opinion, the additional week did not materially affect reported financials.
While Finlay posted a profit in the fourth quarter of the fiscal year ended January 2007, profits from continuing operations were less than the prior year’s, on a comparable basis.
- Valentine’s sales were sluggish – Finlay management noted that the winter storms just prior to Valentine’s Day resulted in “slightly below plan” sales for the company.
- Strong categories included precious metals – Designer jewelry, watches, gold, and silver were especially strong categories for Finlay’s leased department operations in the fourth quarter.
- Inflation rate up – Finlay’s LIFO provision for 2006 was $7.2 million, roughly three times as large as the prior year’s $2.6 million. The substantially higher LIFO reserve reflects sharply higher costs of precious metals and other commodities used in jewelry.
- Vendor concessions were lower – Management said that vendor concessions were down in 2006 due to its reduced sales volume. We also believe that the company did not hit some of the sales targets that its suppliers had set; thus, rebates and other concessions may have been reduced, as a percentage of sales.
- Finlay doors down by 25 percent -- At the end of the prior fiscal year (fiscal year ended January 2006), the company operated 1,009 doors, including leased departments and Carlyle units. At the end of the most recent fiscal year (January 2007), Finlay operated 758 doors, including leased departments as well as Carlyle and Congress units. That’s a decrease of about one fourth of its retail outlets.
- Gold lease program terminated – During 2006, Finlay terminated its gold leasing program. This added nearly $100 million to its owned (asset) inventory, and reduced consignment inventory by a similar amount. Most retailers have terminated their gold lease programs. In times of stable or declining gold prices, gold lease programs can help keep borrowing costs low. In periods of rapidly rising gold prices, gold lease programs can be detrimental to a company’s financial health.
- Modest sales increases planned for 2007 – Finlay management has planned for same-store sales to be up by 2.5 percent to 3.5 percent in 2007. This would be above last year’s +2.1 percent same-store sales gain from continuing operations. Corporate revenues are expected to be in the $780-800 million range, up from this year’s reported $762 million, but down from a peak of $990 million achieved two years ago. We note, however, that the projected $780-800 million in revenues is not strictly comparable to this past year’s $762 million due to accounting for some additional discontinued operations this year; however, the bottom line is that Finlay’s revenues will be up by some notable increment this year.
At the end of the year (January 2008), we expect Finlay to be operating about 731 units, down about 4 percent from the beginning of the year. The company is expected to close 33 Parisian units in July, but will add 12 units – at Federated, Dillards, Bon Ton, and Carlyle – and close 6 non-Parisian units. Management expects Finlay’s reported gross margin to rise by about 50 basis points due to an expected lower LIFO provision (essentially, management is betting that gold, silver, platinum, and diamond prices won’t rise sharply in 2007).
Its merchandise margin is expected to be about flat, prior to the LIFO provision. The company’s tax provision is expected to be about 23.6 percent in 2007, roughly half of 2006’s tax provision of 42.1 percent. With huge swings in the tax provision, net income (after-tax income) is simply not comparable on a year-to-year basis; thus, IDEX Online Research uses pretax income from continuing operations as a way of providing the most transparency and “leveling the playing field.”