Finlay Enterprises, Inc. Q3 2008 Earnings Call Transcript

Finlay Enterprises, Inc. (FNLY)

Q3 2008 Earnings Call

December 4, 2008 10:00 am ET

Executives

Joseph M. Melvin - President and Chief Operating Officer

Bruce E. Zurlnick - Senior Vice President, Treasurer, and Chief Financial Officer

Arthur E. Reiner - Chairman, Chief Executive Officer

Presentation

Operator

Good morning ladies and gentlemen and welcome to the Finlay Enterprises Third Quarter Earnings Conference Call. (Operator Instructions).

I would now like to introduce Miss Caren Villarreal of Financial Dynamics.

Caren Villarreal

Good morning and welcome to the third quarter conference call for Finlay Enterprises.

During the course of this conference call the company may make projections or other forward-looking statements regarding future events and the future financial performance of the company. We wish to caution you that such statements are just predictions and the actual events or results may differ materially.

We refer you to the company’s most recent filings with the Securities and Exchange Commission for additional information on risk factors which could cause actual results to differ materially from current expectations.

I would now like to turn the call over to Art Reiner, Chairman and Chief Executive Officer.

Art Reiner

Good morning and thank you for joining us for our third quarter earnings call. With me today are Joe Melvin our Chief Operating Officer and Bruce Zurlnick our Chief Financial Officer. I will make my initial comments and Bruce will review and detail our financial results for the third quarter.

As was the case for many in our industry, our third quarter results were impacted by on going macro economic challenges. In an effort to mitigate the impact of these challenges we are carefully managing our expenses, our inventory investments, and capital expenditures. We will conservatively manage our business and visually monitor our levels of liquidity in order to have the financial flexibility to manage through this tough environment.

We have lowered our department store inventory at the end of the third quarter by over $80 million from last year and by the end of the fourth quarter we estimate to have approximately $100 million less than the same period last year.

Our focus on lowering expenses in 2009 will be directed in the field and main office. The closing of groups and elimination of underperforming stores in the on going groups, combined with the elimination of approximately 20% of our administrative expenses will represent the critical initiatives in the reduction of our SG&A.

Our aggressive approach in closing under-performing department stores and specialty stores will improve our cash flow. We will leave no stone unturned as we reevaluate each store and its contribution as well as all divisional expense items.

We have reevaluated our capital expenditures for 2009 and we have lowered our original plan from $20 million to approximately $8 million. Our Bailey Banks & Biddle group will open four replacement stores that were committed to in early 2007 and early 2008. The four replacement stores will be in Birmingham, Alabama, Houston, Texas, Cherry Hill, New Jersey, and Portland, Oregon. At this time, we do not expect to open any additional stores beyond these four replacement stores in 2009.

Last week we completed a debt restructuring which enhances our liquidity by increasing our availability under our existing revolving credit facility as a result of a cash infusion and a deferment of cash interest payments. We are pleased to have received the support of our bondholders in this transaction. Bruce will provide more detail on this restructuring in a few moments.

We have been converting our company from a business that was 100% leased department stores to a better balance of specialty stores and department stores in a period that has been very challenging for all retailers. Although we are disappointed with our recent results, we remain focused on our objective of creating a company that will be successful when the economy begins to improve.

We continue to strive to combine a creative merchandising and marketing strategy with superior customer service to build a distinctive business. We operate under great brand names that include Bailey Banks & Biddle, Carlyle, J.E. Caldwell, Park Promenade, Congress, Bloomingdale’s, and Macy’s. Even in challenging times these names enlist a strong brand loyalty and remain traditional and respected institutions in their respective communities.

In support of these brands we have a talented organization to drive this challenging transition to a more diversified business with a focus on future profitability.

We will continue to exercise discipline in managing our expenses, monitoring our cash requirements, and intensifying our marketing initiatives to achieve our goals.

I will now turn the call over to Bruce to review the details of our operating results for the third quarter. We will then open up the call to answer your questions.

Bruce Zurlnick

This morning I will review our third quarter financial results. My discussion today will compare the statement of operations for the third quarter and nine months of 2008 with that of the prior year on a continuing operations basis excluding the results from discontinued Parisian stores closed in 2007 which were reflected in discontinued operations.

Sales increased 12.9% to $160.3 million in the third quarter compared with $141.9 million in the third quarter of the prior year. The specialty division, consisting of Bailey Banks & Biddle, Carlyle, and Congress contributed sales of $58 million in the quarter compared to $23.6 million in the same period of the prior year.

Same store sales decreased 13.5% in the third quarter excluding the Macy’s and Lord & Taylor stores that are scheduled to close at year-end. For the nine months ended November 1, 2008 sales increased 22.8% to $556 million compared to $452.8 million in the first nine months of fiscal 2007 on a continuing operations basis. Specialty jewelry stores totaled $210.6 million for the first nine months as compared to $77.9 million in the same period of fiscal 2007. Same store sales for the nine months decreased 7%.

Gross margin for the third quarter was 41.8% of sales as compared to 45.1% of sales in the third quarter of the prior year. The variance to the prior year is primarily attributable to increased specialty division volume at lower gross margins including sales from Bailey Banks & Biddle, which was acquired in November 2007; total specialty division sales represented 36% of consolidated sales for the quarter compared to last years 17%.

A higher LIFO charge in the third quarter compared to the prior year: the LIFO charge for the third quarter totaled $3.6 million compared to $1.5 million in the prior year. The higher LIFO charge had a 120 basis point impact on third quarter of 2008.

Lower margins at the Macy’s and Lord & Taylor stores that are scheduled to close at year end: as we liquidate inventory and generate cash gross margin in the quarter at the closing stores was approximately 400 basis points lower than at the go-forward leased stores.

Selling general and administrative expense was 55.1% of sales for the third quarter of 2008 compared with 48.7% in the prior years third quarter. The comparable store sales decrease of 13.5% had a significant impact on the increase of SG&A as a percent of sales and certain fixed costs cannot be leveraged. Additionally, incremental rent expenses associated with the specialty division with the addition of Bailey Banks & Biddle resulted in an increase in total SG&A as a percentage of sales for the quarter of approximately 230 basis points.

SG&A for the third quarter included approximately $800,000 for consulting fees associated with the debt restructure. Consulting costs for the first nine months totaled $1.5 million. SG&A for the third quarter also included an accrual of approximately $400,000, the severance associated with the Macy’s and Lord & Taylor closing stores; these costs totaled $1.2 million for the first nine months.

Depreciation and amortization in the third quarter totaled $4.5 million compared with $3.6 million in the prior year period which reflects the additional depreciation of Bailey Banks & Biddle. In addition the current quarter included $500,000 for accelerated depreciation charges associated with the closing stores and for the nine-month period these charges totaled approximately $1.6 million.

Average borrowings on our $550 million revolving credit facility during the quarter totaled $335 million compared to $119 million in the prior years third quarter. The additional borrowings were primarily used to finance the Bailey Banks & Biddle acquisition in the fourth quarter of 2007.

Interest expense totaled $9 million in the third quarter compared with $6.8 million in the prior year period. Interest expense increased largely as a result of higher average borrowings as average interest rates on the revolver were approximately 2.2% lower at 4.9%. The current quarter includes approximately $500,000 of non-cash interest associated with amortization of deferred financing costs.

Net loss and net loss per share for the third quarter totaled $20.8 million and $2.23 per share respectively compared to a net loss of $7.5 million and net loss per share of $0.82 in the third quarter of 2007.

The current quarter and nine-month period loss from continuing operations and EBITDA reflect the expected interim loss associated with Bailey Banks & Biddle division which was not included in the prior year results. As is the case with most jewelry retailers, the fourth quarter for Bailey Banks & Biddle is expected to account for the majority of its sales and EBITDA for the fiscal year.

As indicated earlier, our third quarter results included a LIFO charge of $3.6 million compared to $1.5 million in the prior year. This increase negatively impacted earnings per share by approximately $0.15 in the third quarter and for the nine-month period LIFO charges totaled $8.7 million compared to $4.4 million in the prior year period. Additionally non-recurring charges associated with the debt restructure as well as severance and accelerated depreciation in conjunction with the Macy’s and Lord & Taylor store closings totaled $1.7 million and had an approximately $0.11 impact on earnings in the current quarter.

Due to certain tax versus book differences the effective tax rate for the current quarter was 40.3% compared to 51.6% for the prior years third quarter. Had the current year’s effective tax rate been applied to the prior year pre-tax loss net loss per share for the third quarter of the prior year would have been $0.20 higher or $1.02 per share.

At the end of the third quarter we operated in a total of 778 locations including 671 leased departments and 107 specialty jewelry stores consisting of 67 Bailey Banks & Biddle, 35 Carlyle and 5 Congress stores. During the third quarter we had three openings, two in Macy’s Central and one in Bon-Ton. We also closed six smaller non-profitable Village stores in the third quarter.

As of November 1, 2008 in our leased division we operated 309 Macy’s stores, 34 with Bloomingdales, 163 with Bon-Ton, 81 with Dillard’s, 47 with Lord & Taylor and 37 with Gottschalks.

I will now review some of the key items on the balance sheet.

Finlay’s leased division asset inventory totaled $283 million compared to last year’s total of $367 million, a decrease of $85 million, or 23%. We have managed our asset receipts in response to the difficult retail environment that we continue to face. In addition, we will maintain our focus on liquidating the inventory of the closing store groups during the fourth quarter. The specialty division’s asset inventory totaled $313 million compared to last year’s total of $91 million. The balance for last year included asset inventory from Carlyle and Congress only and did not include inventory for Bailey Banks & Biddle.

On a consolidated basis asset inventory at the end of the third quarter totaled $596 million compared to $458 million in the prior year as decreases in Finlay’s leased inventory were offset by the addition of Bailey Banks & Biddle inventory.

Finlay’s lease division consignment inventory totaled $136 million compared to last year’s total of $181 million, a decrease of 25%. The specialty division’s consignment inventory totaled $31 million compared to $19 million in the prior year, again including Carlyle and Congress only. Thus consolidated consignment inventory at the end of the third quarter totaled $167 million compared to $200 million in the prior year.

Net fixed assets at November 1, 2008 totaled $76 million compared to $54 million in 2007. The current year includes approximately $22 million associated with the Bailey Banks & Biddle division.

In the third quarter capital expenditures totaled $7.6 million compared to $3.9 million in the prior years third quarter. The current period includes, in total, approximately $3.6 million of expenditures for Bailey Banks & Biddle covering costs of two new stores that we opened in November, some at Sierra in Reno, Nevada and Partridge Creek in Clinton Township, Michigan; costs of the two replacement stores, as well as costs related to the implementation of new POS systems. In addition the current quarter includes expenditures of $500,000 covering two Carlyle replacement stores.

For the nine months capital expenditures totaled $17.9 million which compares to $9 million in the first nine months of the prior year.

We closed the quarter with $353 million outstanding under the revolving credit facility, or short-term borrowings compared with $125 million outstanding at the end of the prior year’s third quarter reflecting the impact of the acquisition of Bailey Banks & Biddle. As of the close of the third quarter we had approximately $72 million in excess availability on our revolving credit facility.

Under the terms of our revolving credit agreement we are required to maintain a minimum of $30 million availability. After taking into consideration this minimum requirement, we had $42 million of excess availability at quarter end, which also represented the low point during the third quarter.

I would like to comment briefly on the recent debt restructuring that we completed last week.

The transaction is a positive development for our company and as Art indicated the cash infusion and the deferment of interest payments enhance our liquidity and increase our availability under our existing revolving credit facility.

The transaction closed on Wednesday November 26 upon the completion of a consent solicitation of bondholders. As a result, we received the $20 million cash investment in the form of new second lien secured notes purchased by certain majority shareholders owning approximately 70% of the previously existing bonds. These notes do not require the payment of cash interest for approximately two years.

Additionally these same majority holders agreed to exchange their existing notes, totaling approximately $140 million, for new third lien secured notes which also do not require the payment of interest for two years. The cash savings as a result of the non-cash pay feature of the exchanged bonds is approximately $12 million on an annual basis. The potential participation of additional bondholders in addition to the majority holders may generate incremental cash investment as well as deferment of additional interest expense.

The interest rate in the new notes issued to replace the existing notes is 8.945% through December 2010, assuming no cash interest payments, and 8 3/8% thereafter.

The new $20 million notes have a coupon of 12.125% through December 2010, again assuming no cash interest payments, and 11.375% thereafter.

The first interest payment required under all the new notes is in June of 2011. The bonds have a maturity date of June 2012.

Given the uncertainty of the macro economic environment in which we are currently operating, we have continued to not comment on our guidance for the full year.

Art, Joe, and I are now prepared to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) There are no questions in queue at this time.

Art Reiner

Thank you very much for joining us on this call and we wish you all a good holiday.

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