Finlay Enterprises, Inc. F2Q08 (Qtr End 08/02/08) Earnings Call Transcript

Finlay Enterprises, Inc. (FNLY)

F2Q08 Earnings Call

August 27, 2008 10:00 am ET

Executives

Caren Barbara - Financial Dynamics

Arthur E. Reiner - Chairman, President, and Chief Executive Officer

Bruce Zurlnick, Senior Vice President and Chief Financial Officer

Analysts

Emily Shanks – Lehman Brothers

James Kim - Symphony [ph] Assets

Presentation

Operator

Welcome to the Finlay Enterprises second quarter conference call. (Operator Instructions). I would now like to introduce Miss Caren Barbara, Financial Dynamics.

Caren Barbara

During the course of this conference call the company may make projections and 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 Mr. Art Reiner, Chairman and Chief Executive Officer.

Arthur Reiner

With me today is Bruce Zurlnick our Chief Financial Officer.

Although our second quarter sales continue to be impacted by the challenging macro economic conditions, we directed our effort towards limiting the impact of the difficult environment by carefully managing our expenditures and by focusing on the ongoing integration of Bailey Banks & Biddle into our organization.

Also in keeping with our efforts to conservatively manage our business we carefully monitored our inventory levels so we could maximize our cash flow. We have been vigilant in making sure that we maintain sufficient levels of liquidity and adequate financial flexibility as we navigate through a tough environment.

At the end of the second quarter we were very close to our original plan for availability under our revolving credit facility. Despite sales that were softer than expected we closed with $307 million outstanding in short-term borrowings and had approximately $104 million in total 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. Taking into consideration this minimum requirement, we had $74 million of excess availability.

Due to our ongoing efforts to carefully manage cash, we are pleased that our low point of availability for August was better than our original plan. We continue to maintain strong working relationships with our vendors.

With that said I will move to a discussion of our specialty and lease business.

Our Bailey Banks & Biddle business has consistently improved during the first half of the year. We are pleased with our customers overall response to our efforts to improve our merchandise assortments. In particular we saw positive trends in the watch and designer jewelry categories in the latter part of the quarter, although the diamond category continued to be challenging. However, our sales trend for diamonds improved from the first quarter in the second quarter.

We believe Bailey Banks & Biddle will become a solid contributor to our business. As such we will continue to intensify our brand building through more focused marketing programs and enhanced in store presentation in all of our specialty retail businesses. Our vision at Finley has been to combine a creative merchandising and marketing strategy with superior customer service in order to build a distinctive and successful business. Our success has and will always be dependent on the quality of our people.

Building and leading our teams is a high priority of our organization. The Bailey Banks & Biddle team in the field is composed of professionals in the field who have great pride in the brand and are dedicated to building a great business. Their talent and determination has and will continue to be a great asset in achieving our plans for the future.

Our Carlyle group has continued to expand in the Southeastern part of the country, as we have opened four new stores, of which one was a replacement, in the first six months of this year. All these stores are in lifestyle centers, which present opportunities for increased profit based on improved lease terms and developer support of capital for new construction.

Our long-term business model focuses on optimizing our growth prospects in Bailey Banks & Biddle and Carlyle, as we transition from a 100% leased business to a more diversified business with a focus on expanding the specialty store division. This division has great brand loyalty and is poised for growth when the economy improves.

Additionally we will aggressively approach the lease business where there is opportunity for increased sales and profit. We are pleased that our Bloomingdale group has grown consistently during the past five years and in 2007 surpassed $100 million in sales. We expect that it will continue to be a leader in our lease division as we build on our previous successes.

Further this year Macy Central has continued to improve its top and bottom line results in spite of the difficult retail environment.

Bloomingdales and Macy Central are our largest groups in the lease division; have been our top performers. Both have outstanding teams that are focused on achieving their goals.

In summary, we are pleased to have a talented organization to drive the challenging transition to a more diversified business with a focus on growth and improved profitability. By continuing to exercise discipline in managing our expenses, monitoring our cash requirements, and intensifying our marketing initiatives, we fully expect to achieve our long-term goals.

I will now turn the call over to Bruce, who will review the details of our operating results in the second quarter. We will then answer your questions.

Bruce Zurlnick

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

Sales increased 28.8% to $190.6 million in the second quarter compared with $148 million in the second quarter of the prior year. The specialty division consisting of Bailey Banks & Biddle, Carlyle, and Congress contributed sales of $74.9 million in the quarter compared to $27 million in the same period of the prior year. Same store sales decreased 4.8% in the second quarter.

For the six months ended August 2, 2008 sales increased 27.3% to $395.7 million compared to $310.9 million in the first six months of fiscal 2007 on a continuing operations basis.

Specialty jewelry store sales totaled $152.6 million for the six months as compared to $54.3 million in the first half of fiscal 2007.

Same store sales for the six months decreased 4.6%.

Gross margin for the second quarter was 44.5% of sales as compared to 46.2% of sales for the second 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 of 2007, total specialty division sales represented 39% of consolidated sales for the quarter compared to last years 18%. A high LIFO charge in the second quarter compared to the prior year. The LIFO charge for the second quarter totaled $2.9 million compared to $1.8 million in the prior year and lower margins at the Macys and Lord & Taylor stores that are scheduled to close at year end as we liquidate inventory and generate cash.

Selling general and administrative expense was 48.2% of sales for the second quarter of 2008 compared with 47.5% in the prior years second quarter. The primary reasons for the increase in SG&A as a percent of sales were the incremental rent expense associated with the specialty division coupled with lower sales levels. These factors resulted in an increase in total SG&A as a percent of sales for the quarter by approximately 80 basis points.

Our ability to leverage back office administrative costs as a result of the successful integration of Bailey Banks & Biddle is reflected in an approximate 100 basis point reduction in administration costs for the first half of the year.

SG&A for the quarter included an accrual of approximately $400,000 for severance associated with Macys and Lord & Taylor clothing stores. Excluding this charge SG&A as a percent of sales was 48% compared to 47.5% in the prior year and these costs for the first six months totaled $800,000.

Depreciation and amortization in the second quarter totaled approximately $4.4 million compared with $3.7 million in the prior year period, which reflects additional depreciation of Bailey Banks & Biddle. In addition, the current quarter includes $500,000 for accelerated depreciation charges associated with the clothing stores and for the six-month period these charges totaled approximately $1.1 million.

Average borrowings on our $550 million revolving credit facility in the quarter totaled $312 million compared to $110 million in the prior years second quarter. The additional borrowings were primarily used to finance the Bailey Banks & Biddle acquisition in the fourth quarter of 2007.

Interest expense totaled $8.8 million in the second quarter compared with $6.4 million in the prior year period. Interest expense increased largely as a result of the higher average borrowings as average interest rates on the revolver were approximately 1.9% lower at 4.9%. The current quarter includes approximately $500,000 of non-cash interest associated with the amortization of deferred financing costs.

On a continuing operations basis net loss and net loss per share for the second quarter totaled $12.3 million and $1.32 per share respectively compared to a net loss of $8.5 million and a net loss per share of $0.93 in the second quarter of 2007. The current quarter and six-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 profitability for the fiscal year.

As indicated earlier our second quarter results included a LIFO charge of $2.9 million compared with $1.8 million in the prior year. This increase negatively impacted earnings per share by approximately $0.05 in the second quarter.

Non-recurring charges totaled $900,000 associated with severance and accelerated depreciation in conjunction with Macys and Lord & Taylor store closings at approximately a $0.06 impact on earnings in the current quarter. Excluding the impact of LIFO provision and the non-recurring charges, net loss per share was $1.06 in the quarter as compared to $0.79 in the prior year.

At the end of the second quarter we operated in a total of 781 locations including 674 lease departments and 107 specialty jewelry stores consisting of 67 Bailey Banks & Biddle, 35 Carlyle and 5 Congress stores.

During the second quarter we had one opening in Macys Central and one closing within our Gottschalks store group. As of August 2, 2008 in our lease division we operated 307 Macys stores, 34 with Bloomingdales, 162 with Bon-Ton, 87 with Dillards, 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 $285 million compared to last year’s total of $336 million, a decrease of $51 million, or 15%. We are focused on monitoring inventory levels and continue to liquidate inventory in the closing store groups. The specialty divisions asset inventory totaled $295 million compared to last years total of $78 million. The balance for last year included assed inventory for Carlyle and Congress only and did not include inventory for Bailey Banks & Biddle.

On a consolidated basis asset inventory at the end of the second quarter totaled $580 million compared with $414 million in the prior year as decreases in Finley leased inventory were offset by the addition of Bailey Banks & Biddle.

Finlay leased division consignment inventory totaled $162 million compared to last year’s total of $169 million, a decrease of 4%.

The specialty division’s consignment inventory totaled $30 million compared to $19 million in the prior year, again including Carlyle and Congress only.

Consolidated consignment inventory at the end of the second quarter totaled $192 million compared with $188 million in the prior year.

Net fixed assets at August 2, 2008 totaled $72 million compared to $54 million in 2007. The current year includes approximately $18 million associated with Bailey Banks & Biddle.

In the second quarter capital expenditures totaled $4.2 million compared to $1.4 million in the prior years second quarter. The current period includes approximately $1.5 million covering two new stores that we plan to open in November, some at Sierra in Reno, Nevada and Partridge Creek in Clinton Township, Michigan, as well as additional costs for the Fair Oaks mall store in Fairfax, Virginia that was relocated in June. In addition, the current quarter includes $800,000 in additional disbursements covering the four new Carlyle stores opened in the first quarter.

For the six months capital expenditures totaled $10.3 million which compares to $5.1 million in the first half of the prior year. We continue to project capital expenditures for fiscal 2008 to be approximately $18 to $20 million.

We closed the quarter with $307 million outstanding under the revolving credit facility or short-term borrowings compared with $102 million outstanding at the end of the prior years second quarter, reflecting the impact of the acquisition of Bailey Banks & Biddle.

As of the close of the second quarter we had approximately $104 million in total excess availability on our revolving credit facility. Under the terms of the revolving credit agreement we are required to maintain a minimum of $30 million availability. After taking into consideration this minimum requirement we had $74 million of excess availability at quarter end.

Our low point of excess availability during the quarter was in mid-July at which time our borrowings were $323 million and we had approximately $97 million in total excess availability on our revolving credit facility before considering the minimum requirement. These levels of excess availability in the second quarter are very close to our original projections, despite softer than expected top line sales. The availability levels reflect our continued focus on conservative cash management.

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

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Emily Shanks with Lehman Brothers.

Emily Shanks – Lehman Brothers

Can you give us a little bit of color around traffic versus ticket trends during the quarter?

Arthur Reiner

Traffic has been off in the malls both in our specialty stores where we have traffic counts; we have noted that traffic is off in those malls: we believe, from what we’ve heard, is often department stores also and our check has moved up in total about 5%.

Emily Shanks – Lehman Brothers

Then can you speak to any geographical trends that you may have seen?

Arthur Reiner

Geographical trends the strongest region in the country for it is Texas. That has been the best and Baileys has a concentration of stores there as does Macys. The northeast has been maybe the second best. I would say the weakest areas have been Florida or northeast and southeast have been reasonably good. California in the Bloomingdales group has performed well for us in the second quarter and seems to be coming back, although I believe California’s business in total is not good. I think the mid-west business still remains challenging and difficult and that’s pretty much it. In August I think the Florida business has been hurt by Faye last week and that closed a number of locations for a period of time, so we had that on top of the Florida business in addition to whatever a challenging trend in Florida has been.

Emily Shanks – Lehman Brothers

Also this is a question on comps, can you just give us the color around what the free standing comps are doing specifically?

Arthur Reiner

We don’t split our comps out by group.

Operator

Your last question comes from Bernie Wong with Symphony [ph] Assets.

James Kim - Symphony [ph] Assets

Hi this is actually James Kim. Can you guys maybe shed some light on what you expect the low point of your revolver availability to be from now to the end of the year?

Arthur Reiner

What we had said previously, James, is that we had expected the low point of availability to be approximately $50 million, which really falls in the middle of the year based on the advance rates that are in our revolving credit agreement and as Art indicated earlier, at this point in time in the month of August we were somewhat better than that in our mid-month availability.

James Kim - Symphony [ph] Assets

I know it’s not exactly comparable given your acquisition of Bailey Banks, but can you talk about what the excess availability was last year at this time?

Arthur Reiner

It was a different revolver, it’s really not comparable, because what we did is we add a new revolver in November, so we went from a $350 million revolver to a $550 million revolver?

Bruce Zurlnick

Yes, $300 to $305.50, but yes it was a different structural asset and we hadn’t closed on the acquisition at that point, but I’m sure the availabilities were probably somewhat higher than that.

Arthur Reiner

Thanks everybody who tuned in today in a holiday week. We appreciate your continuing interest to Finlay and we will continue to work diligently at keeping you informed about your progress. Thank you.

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