Finlay management reported that sales at the acquired Bailey Banks & Biddle (BBB) stores have slowed notably since late October or so. Since mid 2006, BBB’s same-store sales have been about flat and in the past few weeks they have turned negative.

 

This is a disturbing trend in the face of the current holiday selling season, since it may be a harbinger of short-term tough trends which are facing all American jewelers. 

 

BBB’s weakening sales are likely due to two factors, according to Finlay management: 1) disruptions related to the acquisition and transition in ownership from Zale to Finlay in early November; and 2) a high mix of diamond jewelry.

 

According to Finlay management, diamond sales, especially higher ticket diamonds, have softened in recent weeks.

 

Interestingly, Tiffany obliquely confirmed this same trend: its fastest growing price range is no longer diamonds prices $50,000 and higher; demand has stepped down, and jewelry priced $4,000 to $50,000 was the fastest growing category in the most recent quarter. However, in the global market, polished diamond prices, especially among larger stones, have continued to soar in recent months.

 

IDEX Online conducted independent research and has determined that other U.S. retailers are also seeing some weakness at the retail level for diamonds in the 2-3 carat range. Vendors are no longer demanding a premium price for diamonds in this size range; further, vendors have begun to offer memo deals for diamonds in the 0.5-3.0 carat range, something that would not have been available a year ago.

 

It is important to note, however, that sales in Finlay’s core businesses – leased departments and specialty jewelers (Carlyle and Congress) – are running at about the same pace as earlier this year.

 

For the third quarter ended October, same-store sales were up 1.6 percent; for the first half of the year from February through July, same-store sales were up about 2.4 percent. Thus, we believe that Finlay’s same-store sales are positive by 1-2 percent through late November.

 

Finlay Cuts Holiday Sales Forecast

Finlay reduced its guidance for sales in the all-important fourth quarter. Earlier, management was forecasting same-store sales gains in the 2.5 percent-3.5 percent range. Now, it is predicting same-store sales gains in the 1.5 percent-to-2.5 percent range. In part, this reduced forecast is due to the addition of Bailey Banks; in part, it is due to weakening consumer fundamentals.

 

The Future of Bailey Banks & Biddle

On a conference call with Wall Street analysts, Finlay management outlined some preliminary plans for BBB.

 

• Finlay has Rolex in some of its specialty jewelry stores, but BBB does not have Rolex. It is possible that BBB could start carrying Rolex, pending approval from the manufacturer.

• Of the current 70 BBB stores (this will drop to 68 units after Christmas), there is overlap with only 1 Congress store and 3 Carlyle stores. In other words, 94 percent of the BBB stores have no overlap with Finlay specialty jewelry units.

• Finlay will not begin to have an impact on BBB’s merchandising until late spring or early fall.

• Finlay thinks there is an opportunity for BBB in three product categories: 1) watches; 2) designer jewelry; and, 3) fashion jewelry. BBB’s product mix includes about 50 percent diamonds and diamond jewelry; this will probably not change. Finlay’s merchandise line-up is much more fashion-oriented and includes a heavy mix of watches.

• BBB’s inventory turn is at about the industry average of one time per year. Finlay’s goal is to try to improve that turn. Currently, BBB has only about $30-40 million of memo inventory, a modest level compared to Finlay which heavily utilizes memo goods.

• For the fiscal year ended July 2007, BBB generated about $284 million in revenues. Finlay estimates that BBB will contribute $280-300 million in its first year. That will bring Finlay’s total revenues back to near $1 billion annually, a level where the company peaked, before some of its leased department clients severed their relationship with Finlay.

 

Other Third Quarter Highlights

The following table summarizes financial highlights from the three-month period ended October 2007.

 

Other management comments about the October quarter that were noteworthy to the jewelry industry are as follows:

 

• Key product categories that were strong in the October quarter and that are likely to be strong during the holiday selling season include diamonds, such as Journey, diamond hoop earrings, better silver with diamonds or colored gemstones, watches, and designer jewelry.

• Sales in the Florida region have picked up somewhat from earlier this year. The Midwest is now the weakest region of the country for Finlay.

• Finlay’s gross margin fell to 45.1 percent of sales from last year’s 46.4 percent due to three key factors: 1) a larger sales mix of lower margin designer jewelry and watches; 2) a higher mix of sales from specialty jewelry units which operate with inherently lower margins; and, 3) higher materials costs, especially gold.

• Finlay’s operating costs dropped to 48.7 percent of sales from last year’s 49.5 percent due to lower back office costs. Finlay management has done a great job of “right-sizing” its overhead costs, after it lost significant business over the past two years.

• In response to an analyst’s question about the impact of Blue Nile on Finlay, management noted that Finlay is not in the single-diamond business, a category that Blue Nile dominates. Management went on to say that Blue Nile has created a new awareness of diamond pricing with consumers, but Blue Nile’s activities have had no measurable impact on Finlay’s sales.

• Management said it had no new leased department opportunities on the immediate horizon, other than growing with its core existing customers. Finlay’s chairman, Art Reiner, has made it clear that he believes the company’s future lies in the higher end of the jewelry business. Hence, it is no surprise that the company’s recent acquisitions include guild jewelers such as Carlyle, Congress and BBB.