10-K 1 file1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended February 3, 2007 or

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to

Commission file number: 33-59380

FINLAY FINE JEWELRY CORPORATION *

(Exact name of registrant as specified in its charter)


Delaware 13-3287757
State or other jurisdiction of
incorporation or organization
(I.R.S. Employer
Identification No.)
529 Fifth Avenue, New York, NY 10017
(Address of principal executive offices) (Zip Code)
212-808-2800
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   [ ]    No   [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes   [X]    No   [ ]

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   [ ]    No   [X]

*(Note: As a voluntary filer, not subject to the filing requirements, the registrant filed all reports under Section 13 or 15(d) of the Exchange Act during the preceding 12 months.)

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    Not Applicable

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of ‘‘accelerated filer and large accelerated filer’’ in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer    [ ]                Accelerated filer    [ ]            Non-accelerated filer    [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   [ ]    No   [X]

As of April 13, 2007, there were 1,000 shares of common stock, par value $.01 per share, of the registrant outstanding. As of such date, all shares of common stock were owned by the registrant’s parent, Finlay Enterprises, Inc., a Delaware corporation. The market value of the registrant’s voting and non-voting common equity held by non-affiliates was $0 as of July 29, 2006.




FINLAY FINE JEWELRY CORPORATION

FORM 10-K

FOR THE FISCAL YEAR ENDED FEBRUARY 3, 2007

INDEX


    Page(s)
PART I    
Item 1. Business 3
Item 1A. Risk Factors 13
Item 1B. Unresolved Staff Comments 16
Item 2. Properties 16
Item 3. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 17
PART II    
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 18
Item 6. Selected Consolidated Financial Data 18
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 21
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 41
Item 8. Financial Statements and Supplementary Data 42
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 43
Item 9A. Controls and Procedures 43
Item 9B. Other Information 43
PART III    
Item 10. Directors, Executive Officers and Corporate Governance 44
Item 11. Executive Compensation 46
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 67
Item 13. Certain Relationships and Related Transactions, and Director Independence 70
Item 14. Principal Accountant Fees and Services 71
PART IV    
Item 15. Exhibits and Financial Statement Schedules 73
SIGNATURES 79

2




PART I

Item 1.    Business

The Company

Finlay Fine Jewelry Corporation, a Delaware corporation, and its wholly-owned subsidiaries (‘‘Finlay Jewelry’’, the ‘‘Registrant’’, ‘‘we’’, ‘‘us’’ and ‘‘our’’) is a wholly-owned subsidiary of Finlay Enterprises, Inc., a Delaware corporation (the ‘‘Holding Company’’). References to ‘‘Finlay’’ mean, collectively, the Holding Company and Finlay Jewelry. All references herein to ‘‘departments’’ refer to fine jewelry departments operated pursuant to license agreements with host stores.

We are one of the leading retailers of fine jewelry in the United States. We primarily operate licensed fine jewelry departments in major department stores for retailers such as Federated Department Stores, Inc. (‘‘Federated’’), The Bon-Ton Stores, Inc. (the ‘‘Bon-Ton’’) and Dillard’s, Inc. (‘‘Dillard’s’’). We sell a broad selection of moderately priced fine jewelry, including necklaces, earrings, bracelets, rings and watches, and market these items principally as fashion accessories with an average sales price of approximately $248 per item. Average sales per department were $917,000 in 2006 and the average size of a department is approximately 800 square feet.

In November 2006, we completed the acquisition of L. Congress, Inc. (‘‘Congress’’), a privately-owned regional chain of five jewelry stores located in southwest Florida, with annual sales of approximately $23.6 million in 2006 and a focus on the luxury market.

In May 2005, we completed the acquisition of Carlyle & Co. Jewelers (‘‘Carlyle’’). Carlyle currently operates 33 specialty jewelry stores located primarily in the southeastern United States under the Carlyle & Co., J.E. Caldwell & Co. and Park Promenade trade names, which sell luxury priced jewelry, with an average sales price of approximately $1,400 per item. The Carlyle stores are principally located in shopping malls and lifestyle centers and focus on the designer and high-end jewelry markets. Average sales per store were $3.1 million in 2006 and the average size of a store is approximately 2,100 square feet. Carlyle generated sales of approximately $101.6 million in 2006.

As of February 3, 2007, we operated a total of 758 locations, including 720 Finlay departments in eleven host store groups in 40 states and the District of Columbia, as well as 33 Carlyle specialty jewelry stores in nine states and five Congress specialty jewelry stores located in southwest Florida. Our largest host store relationship is with Federated, for which we have operated departments since 1983. During 2006, store groups owned by Federated accounted for 57% of our sales (excluding the Federated departments that closed in 2006, discussed below, and Lord & Taylor, which was sold to NRDC Equity Partners LLC in late 2006).

In August 2005, Federated announced that it had completed its acquisition of The May Department Stores Company (‘‘May’’). In September 2005, Federated announced its integration plans including a divisional realignment and divestiture of certain stores. As of February 3, 2007, we operated a total of 349 departments in five of Federated’s eight divisions, which excludes 194 departments that were either divested or phased into the Macy’s East or Macy’s West divisions during the first half of 2006. In 2006, we generated sales of approximately $105.9 million from these 194 departments.

In November 2005, we signed new agreements with Federated for the Macy’s Midwest and Macy’s North divisions and amended our existing Macy’s Northwest and Macy’s South agreements, effective at the beginning of 2006. The agreements expire on January 31, 2009, and cover approximately 317 departments in total. In addition to extending our agreements for three years, all non-compete provisions from the previous May contracts that required us to obtain May’s permission before opening a new department or store within a certain radius of a May store, were eliminated. We believe that the elimination of this non-compete provision provides us with significantly greater opportunity to expand our business and continue to diversify beyond the traditional department store sector. The agreement has no impact on the Bloomingdale’s division whose license agreement, covering 32 departments, currently runs through January 30, 2010. In October 2006, Federated sold its

3




Lord & Taylor division to NRDC Equity Partners LLC. Our current agreement with Lord & Taylor is two years in length expiring January 31, 2009 and covers 49 departments.

In May 2006, the Holding Company announced that Belk, Inc. (‘‘Belk’’) would not renew our license agreement due to Belk’s acquisition of a privately-held company that licensed fine jewelry departments in certain of the Belk stores. The termination of the license agreement, effective at the end of 2006, resulted in the closure of 75 departments. In 2006, we generated sales of approximately $51.9 million from the Belk departments. Further, as a result of Belk’s acquisition of Parisian from Saks Incorporated (‘‘Saks’’) in October 2006, the Parisian departments will close in July 2007. In 2006, we generated sales of approximately $22.9 million from our 33 Parisian departments.

In December 2006, our revolving credit agreement with General Electric Capital Corporation (‘‘G.E. Capital’’) and certain other lenders was amended and restated (the ‘‘Revolving Credit Agreement’’). The Revolving Credit Agreement, which matures in January 2011, provides us with a senior secured revolving line of credit up to $225.0 million (the ‘‘Revolving Credit Facility’’).

Effective as of November 29, 2006, we entered into an agreement to terminate and retire the obligation under the amended and restated gold consignment agreement (the ‘‘Gold Consignment Agreement’’), which was an off-balance sheet arrangement. Under the Gold Consignment Agreement, we were able to receive consignment merchandise by providing gold, or otherwise making payment, to certain vendors. The Gold Consignment Agreement permitted us to consign up to the lesser of (i)165,000 fine troy ounces or (ii) $50.0 million worth of gold, subject to a formula prescribed by the agreement. In accordance with the termination agreement, we paid approximately $49.9 million to purchase the outstanding gold. The purchased gold is reflected as inventory on our Consolidated Balance Sheets from the date of purchase. Payment of the $49.9 million was financed through additional borrowings under the Revolving Credit Agreement.

Our fiscal year ends on the Saturday closest to January 31. References to 2007, 2006, 2005, 2004, 2003 and 2002 relate to the fiscal years ending or ended on February 2, 2008, February 3, 2007, January 28, 2006, January 29, 2005, January 31, 2004 and February 1, 2003, respectively. Each of the fiscal years includes 52 weeks except 2006, which includes 53 weeks.

We were initially incorporated on August 2, 1985 as SL Holdings Corporation (‘‘SL Holdings’’). The Holding Company, a Delaware corporation incorporated on November 22, 1988, was organized by certain officers and directors of SL Holdings to acquire certain operations of SL Holdings. In connection with a reorganization transaction in 1988, which resulted in the merger of a wholly-owned subsidiary of the Holding Company into SL Holdings, SL Holdings changed its name to Finlay Fine Jewelry Corporation and became a wholly-owned subsidiary of the Holding Company. Additionally, in connection with the acquisitions of Carlyle and Congress, each became a wholly-owned subsidiary of ours. Our principal executive offices are located at 529 Fifth Avenue, New York, New York 10017 and our telephone number at this address is (212) 808-2800.

General

Overview

Department Store Based Fine Jewelry Departments.    Host stores benefit from outsourcing the operation of their fine jewelry departments. By engaging us, host stores gain specialized managerial, merchandising, selling, marketing, inventory control and security expertise. Additionally, by avoiding the high working capital investment typically required of the jewelry business, host stores improve their return on investment and can potentially increase their profitability.

As a licensee, we benefit from the host stores’ reputation, customer traffic, advertising, credit services and established customer base. We also avoid the substantial capital investment in fixed assets typical of stand-alone retail formats. These factors have generally enabled our new departments to achieve profitability within their first twelve months of operation. We further benefit because net sales proceeds are generally remitted to us by each host store on a monthly basis with essentially all customer credit risk borne by the host store.

4




As a result of our strong relationships with our vendors, our management believes that our working capital requirements are lower than those of many other jewelry retailers. At the end of 2006, approximately 30% of our merchandise was held on consignment. The use of consignment merchandise also reduces our inventory exposure to changing fashion trends because unsold consigned merchandise can be returned to the vendor.

Stand-Alone Jewelry Stores.    Our stand-alone jewelry stores, comprised of Carlyle and Congress operate luxury jewelry stores and offer compelling shopping environments for the high-end luxury consumer. Our stand-alone jewelry stores carry exclusive and recognized branded and designer merchandise selections and merchandise assortments focus on watches, gold, designer jewelry, diamonds and precious gemstones, complemented by an assortment of giftware.

Our stand-alone jewelry stores strive to provide their customers with a premier shopping experience by utilizing knowledgeable, professional and well-trained sales associates, marketing programs designed to promote customer awareness of their merchandise assortments and extending credit to their customers through their credit card programs.

Industry.    Consumers spent approximately $63.0 billion on jewelry (including both fine and costume jewelry) in the United States in 2006, an increase of approximately $22.0 billion over 1996, according to the United States Department of Commerce. In the department store and specialty jewelry store sectors in which we operate, consumers spent an estimated $12.3 billion on fine jewelry in 2005. We believe that demographic factors such as the maturing U.S. population and an increase in the number of working women, have resulted in greater disposable income, thus contributing to the growth of the fine jewelry retailing industry. Our management also believes that jewelry consumers today increasingly perceive fine jewelry as a fashion accessory, resulting in purchases which augment our gift and special occasion sales.

Growth Strategy.    We intend to continue to pursue the following key initiatives to increase sales and earnings:

  Increase Comparable Store Sales in our Departments.    In our department store based fine jewelry departments, our merchandising and marketing strategy includes emphasizing key merchandise items, increasing focus on holiday and event-driven promotions, participating in host store marketing programs and positioning our departments as ‘‘destination locations’’ for fine jewelry. We believe that comparable store sales (sales from locations open for the same months during the comparable period) will continue to benefit from these strategies. Over the past decade, we have experienced comparable store sales increases (in nine out of ten years) and have consistently outperformed our host store groups with respect to these increases.
  Add New Stand-Alone Jewelry Stores and Increase Comparable Store Sales.    Opening new stores and increasing comparable store sales is part of our long-term growth plan. We plan to open one new Carlyle store in 2007 and two additional stores in 2008. We are currently evaluating new store opportunities for Congress.
  Open New Channels of Distribution.    An important initiative and focus of management is developing opportunities for our growth. We consider it a high priority to identify new businesses, such as additional regional jewelry chains that offer growth, financial viability and manageability and will have a positive impact on shareholder value.
  Add Departments Within Existing Host Store Groups.    Our well established relationships with many of our host store groups have enabled us to add departments in their new store locations. We also seek to add departments within existing host stores that do not currently operate jewelry departments. For example, over the past three years, we added 30 departments in Dillard’s and we plan to add three departments within this host store group in 2007. In addition, we plan to open departments in two Bloomingdale’s stores and three Macy’s stores in 2007.

5




  Establish New Host Store Relationships.    We have an opportunity to grow by establishing new relationships with department stores that presently operate their own fine jewelry departments or have an interest in opening jewelry departments. We seek to establish these new relationships by demonstrating to department store management the potential for improved financial performance. Through acquisitions, we added Marshall Field’s (now Macy’s North), Dillard’s and Bloomingdale’s to our host store relationships.
  Improve Operating Leverage.    We seek to continue to leverage expenses both by increasing sales at a faster rate than expenses and by reducing our current level of certain operating expenses. For example, we have demonstrated that by increasing the selling space (with host store approval) of certain high volume departments, incremental sales can be achieved without having to incur proportionate increases in selling and administrative expenses. In addition, our management believes we will benefit from further investments in technology and refinements of operating procedures designed to allow our sales associates more time for customer sales and service. Our merchandising and inventory control systems and our point-of-sale systems for our locations provide the foundation for improved productivity and expense control initiatives. Further, our central distribution facilities enhance our ability to optimize the flow of merchandise to selling locations and to reduce payroll and freight costs.
  Enhance Customer Service Standards and Strengthen Selling Teams.    We are continuously developing and evaluating our selling teams. One of our priorities is to effectively manage personnel at our store locations, as they are the talent driving our business at the critical point of sale. We place strong emphasis on training and customer service. We have expanded our interactive, web-based training programs in recent years to provide our associates with a uniform training experience. In order to further our goals of optimizing service levels and driving sales growth, we will continue to incentivize our sales associates by providing performance-based compensation and recognition.

Merchandising Strategy.    In our department store based fine jewelry departments, we seek to maximize sales and profitability through a unique merchandising strategy known as the ‘‘Finlay Triangle’’, which integrates store management (including host store management and our store group management), vendors and our central office. By coordinating efforts and sharing access to information, each Finlay Triangle participant plays a role which emphasizes its area of expertise in the merchandising process, thereby increasing productivity. Within guidelines set by the central office, our store group management contributes to the selection of the specific merchandise most appropriate to the demographics and customer tastes within their particular geographical area. Our advertising initiatives and promotional planning are closely coordinated with both host store management and our store group management to ensure the effective use of our marketing programs. Vendors participate in the decision-making process with respect to merchandise assortment, including the testing of new products, marketing, advertising and stock levels. By utilizing the Finlay Triangle, opportunities are created for the vendor to assist in identifying fashion trends thereby improving inventory turnover and profitability, both for the vendor and us. As a result, our management believes it capitalizes on economies of scale by centralizing certain activities, such as vendor selection, advertising and planning, while allowing store management the flexibility to implement merchandising programs tailored to the host store environments and clientele.

6




The Finlay Triangle

We have structured our relationships with vendors to encourage sharing of responsibility for marketing and merchandise management. We furnish to vendors, through on-line access to our information systems, the same sales, stock and gross margin information that is available to our store group management and central office for each of the vendor’s styles in our merchandise assortment. Using this information, vendors are able to participate in decisions to replenish inventory which has been sold and to return or exchange slower-moving merchandise. New items are tested in specially selected ‘‘predictor’’ departments where sales experience can indicate an item’s future performance in our other departments. Our management believes that the access and input which vendors have in the merchandising process results in a better assortment, more timely replenishment, higher turnover and higher sales of inventory, differentiating us from our competitors.

Since many of the host store groups in which we operate differ in fashion image and customer demographics, our flexible approach to merchandising is designed to complement each host store’s own merchandising philosophy. We emphasize a ‘‘fashion accessory’’ approach to fine jewelry and watches, and seek to provide items that coordinate with the host store’s fashion focus as well as to maintain stocks of traditional and gift merchandise.

The merchandising strategy for our stand-alone jewelry stores is built around their customer profiles and partnerships with suppliers. Through analysis of customer demographics, fashion trends, industry trends and vendor and store management recommendations, they seek to maximize sales and profitability by merchandising to the customer tastes within the geographic areas in which they operate.

7




Store Relationships

Department Store Based Fine Jewelry Relationships.    The following table identifies the host store groups in which we operated department store based fine jewelry departments at February 3, 2007, the year in which our relationship with each host store group commenced and the number of departments operated by us in each host store group.


Host Store Group Inception of
Relationship
Number of
Departments
 
Federated      
Macy’s South 1983 140  
Macy’s Midwest 1992 *  84  
Macy’s Northwest 1993 37  
Macy’s North 1997 *  56  
Subtotal Macy’s   317  
Bloomingdale’s 2000 32  
Total Federated Departments     349
Bon-Ton      
The Bon-Ton/Elder-Beerman 1986 80  
Carson Pirie Scott/Bergner’s/Boston Store/Younkers/Herberger’s 1977 82  
Total Bon-Ton Departments     162
Other Departments      
Gottschalks 1969 39  
Lord & Taylor 1978 *  49  
Dillard’s 1997 88  
Parisian** 1997 33  
Total Other Departments     209
Total Departments     720
* Represents the year in which our relationship began with the host store group previously owned by May.
** We will operate the Parisian departments through July 2007.

Terms of Department Store Based Fine Jewelry License Agreements.    Our license agreements typically have an initial term of one to five years. All of our license agreements contain provisions for automatic renewal absent prior notice of termination by either party. License agreement renewals range from one to five year periods. In exchange for the right to operate a department within the host store, we pay each host store group a license fee, calculated as a percentage of sales.

Our license agreements typically require host stores to remit sales proceeds for each month (without regard to whether such sales were cash, store credit or national credit card) to us approximately three weeks after the end of such month. Additionally, substantially all of our license agreements provide for accelerated payments during the months of November and December, which require the host store groups to remit to us 75% of the estimated months’ sales prior to or shortly following the end of each such month. Each host store group withholds from the remittance of sales proceeds a license fee and other expenditures, such as advertising costs, which the host store group may have incurred on our behalf.

We are usually responsible for providing and maintaining any fixtures and other equipment necessary to operate our departments, while the host store is typically required to provide clean space for installation of any necessary fixtures. The host store is generally responsible for paying utility costs (except certain telephone charges), maintenance and certain other expenses associated with the operation of the departments. Our license agreements typically provide that we are responsible for the hiring (subject to the suitability of such employees to the host store) and discharge of our sales and department supervisory personnel, and substantially all license agreements require us to provide our

8




employees with salaries and certain benefits comparable to those received by the host store’s employees. Many of our license agreements provide that we may operate the departments in any new stores opened by the host store group. In certain instances, we are operating departments without written agreements, although the arrangements in respect of such departments are generally in accordance with the terms described herein.

Credit.    In the department store based fine jewelry departments, substantially all consumer credit risk is borne by the host store rather than by us. Purchasers of our merchandise at a host store are entitled to the use of the host store’s credit facilities on the same basis as all of the host store’s customers. Payment of credit card or check transactions is generally guaranteed to us by the host store, provided that the proper credit approvals have been obtained in accordance with the host store’s policy. Accordingly, payment to us in respect of our sales proceeds is generally not dependent on when, or if, payment is received by the host store.

Our stand-alone jewelry stores maintain private label credit card programs that are managed by a third-party. We have no liability to the card issuer for bad debt expense, provided that purchases are made in accordance with the issuing banks’ procedures. Our stand-alone jewelry stores credit programs are intended to complement their overall merchandising and marketing strategy by encouraging larger and more frequent sales and credit card holders receive special offers and advance notice of in-store sales events. During 2006, such private label credit card purchases accounted for approximately 21.0% of their sales.

Locations Opened/Closed.    During 2006, location openings offset by closings resulted in a net decrease of 251 locations. The openings, which totaled 33 locations, included 26 Finlay departments within existing host store groups, two Carlyle stores and five stores as a result of the acquisition of Congress in November 2006. The closings totaled 284 locations, including 283 Finlay departments and one Carlyle store. See ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations-2006 Compared with 2005’’.

The following table sets forth data regarding the number of locations which we have operated from the beginning of 2002.


  Fiscal Year Ended
  Feb. 3,
2007
Jan. 28,
2006
Jan. 29,
2005
Jan. 31,
2004
Feb. 1,
2003
Locations:          
Open at beginning of year 1,009 962 972 1,011 1,006
Opened during year 33 62 28 32 21
Closed during year (284 )  (15 )  (38 )  (71 )  (16 ) 
Open at end of year 758 1,009 962 972 1,011
Net increase (decrease) (251 )  47 (10 )  (39 )  5

This data has not been restated to exclude discontinued operations. Refer to the Selected Consolidated Financial Data which provides the number of locations at each year end, as restated for discontinued operations. For the years presented in the table above, closings were primarily attributable to: ownership changes in host store groups; internal consolidation within host store groups; the closing or sale by host store groups of individual stores; host store group decisions to consolidate with one licensee or to operate departments themselves; and our decision to close unprofitable locations. To our management’s knowledge, none of the department closings during the periods presented in the table above resulted from dissatisfaction of a host store group with our performance.

Products and Pricing

Each of our locations offers a broad selection of necklaces, earrings, bracelets, rings and watches. Other than watches, substantially all of the fine jewelry items sold by us are made from precious metals and many also contain diamonds or colored gemstones. We also provide jewelry and watch

9




repair services. We do not carry costume or gold-filled jewelry. Specific brand identification is generally not important within the fine jewelry business, except for watches and designer jewelry. The department store based fine jewelry departments emphasize brand name vendors, including Citizen, Bulova, Movado and Seiko with respect to watches. The Bloomingdale’s store group emphasizes designer jewelry including David Yurman, John Hardy, Phillipe Charriol, Roberto Coin and Judith Ripka. The stand-alone jewelry stores emphasize the Rolex watch brand in addition to designer jewelry.

The following table sets forth the sales and percentage of sales by category of merchandise for 2006, 2005 and 2004 (dollars in thousands):


  Fiscal Year Ended
  February 3, 2007 January 28, 2006 January 29, 2005
  Department Store
Based Fine Jewelry
Departments
Stand-alone
Jewelry Stores(1)
Department Store
Based Fine Jewelry
Departments
Stand-alone
Jewelry Stores(2)
Department Store
Based Fine Jewelry
Departments
  Sales % of
Sales
Sales % of
Sales
Sales % of
Sales
Sales % of
Sales
Sales % of
Sales
Diamonds $ 173,304 26.5 %  $ 29,847 27.6 %  $ 173,802 27.1 %  $ 19,462 28.1 %  $ 170,614 26.4 % 
Gemstones 132,978 20.3 10,710 9.9 132,073 20.6 5,159 7.5 137,654 21.3
Gold 123,880 19.0 1,637 1.5 127,145 19.9 1,130 1.6 138,301 21.4
Watches 92,090 14.1 43,185 39.9 89,475 14.0 26,290 37.8 92,416 14.3
Designer 49,420 7.6 15,798 14.6 39,568 6.2 13,278 19.1 37,483 5.8
Other(3) 81,973 12.5 6,973 6.5 78,178 12.2 4,171 5.9 69,797 10.8
Total Sales $ 653,645 100.0 %  $ 108,150 100.0 %  $ 640,241 100.0 %  $ 69,490 100.0 %  $ 646,265 100.0 % 
(1) Sales for 2006 include Congress since the date of acquisition.
(2) Sales for 2005 include Carlyle since the date of acquisition.
(3) Includes special promotional items, remounts, estate jewelry, pearls, beads, cubic zirconia, sterling silver and men’s jewelry, as well as repair services and accommodation sales to our employees.

The department store based fine jewelry departments sell merchandise at prices generally ranging from $100 to $1,000. In 2006, the average price of items sold by these departments was approximately $248 per item. An average department has over 5,000 items in stock. Many of our license agreements with host store groups restrict us from selling certain types of merchandise or, in some cases, selling particular merchandise below certain price points. In 2006, the average price of items sold by our stand-alone jewelry stores was approximately $1,400 and these stores have, on average, approximately 3,000 to 4,000 items in stock.

Consistent with fine jewelry retailing in general, a substantial portion of our department store based fine jewelry sales are made at prices discounted from listed retail prices. Our advertising and promotional planning are closely coordinated with our host store’s marketing efforts. A substantial portion of our sales occur during publicized sales events. The amount of time during which merchandise may be offered at discount prices is limited by applicable laws and regulations. See ‘‘Legal Proceedings’’.

Purchasing and Inventory

General.    A key element of our strategy has been to lower the working capital investment required for operating our existing locations and opening new locations. At the end of 2006, our net investment in inventory (i.e., the total cost of inventory owned and paid for) was approximately 60% of the total cost of our on-hand merchandise. At the end of 2006, approximately 30% of our merchandise was held on consignment and certain additional inventory had been purchased with extended payment terms. We are generally granted exchange privileges which permit us to return or exchange unsold merchandise for new products at any time. In addition, we structure our relationships with vendors to encourage their participation in and responsibility for merchandise management. By making the vendor a participant in our merchandising strategy, we have created opportunities for the

10




vendor to assist in identifying fashion trends, thereby improving inventory turnover and profitability. As a result, our direct capital investment in inventory is at a level which we believe is low for the retail jewelry industry. In addition, this strategy reduces our inventory exposure to changing fashion trends because unsold consignment merchandise can be returned to the vendor.

In 2006, approximately 43.5% of sales related to the department store based fine jewelry departments were generated by merchandise obtained from their ten largest vendors (out of a total of approximately 500 vendors) and, approximately 9.0% of sales related to the department store based fine jewelry departments were generated by merchandise obtained from their largest vendor. Additionally, merchandise obtained from the stand alone jewelry stores’ two largest vendors generated approximately 44% of their sales in 2006.

Operations

General

Department Store Based Fine Jewelry Departments.    Most of our departments have between 50 and 150 linear feet of display cases (with an average of approximately 80 linear feet) generally located in high traffic areas on the main floor of our host stores. Each department is supervised by a manager whose primary duties include customer sales and service, scheduling and training of personnel, maintaining security controls and merchandise presentation. Each department is open for business during the same hours as its host store.

To parallel host store operations, we have established separate group service organizations responsible for managing departments operated for each host store. Staffing for each group organization varies with the number of departments in each group. Typically, we service each host store group with a group manager, an assistant group manager or director of stores, one merchandise manager, one operations manager, one human resources manager, three or more regional supervisors who oversee the individual department managers and a number of clerical employees. Each group manager reports to one of two regional vice presidents. In our continued efforts to improve comparable department sales through improved operating efficiency, we have taken steps to minimize administrative tasks at the department level, to improve customer service and, as a result, sales.

We had average sales per linear foot of approximately $11,500 over the past three years. We determine average sales per linear foot by dividing our sales by the aggregate estimated measurements of the outer perimeters of the display cases of our departments. We had average sales per department of approximately $917,000, $909,000 and $941,000 in 2006, 2005 and 2004, respectively.

Stand-Alone Jewelry Stores.    Each stand-alone jewelry store is supervised by a manager whose primary responsibilities include customer sales and service, scheduling and training of personnel, maintaining security controls and merchandise presentation. For the Carlyle stores, each store manager reports to one of four regional vice presidents, who are responsible for the supervision of up to nine stores. Carlyle had average sales per store of $3.1 million in 2006. For the Congress stores, each store manager reports to the one regional vice president.

Management Information and Inventory Control Systems.    The department store based fine jewelry business, along with its vendors, use our management information systems to monitor sales, gross margin and inventory performance by location, merchandise category, style number and vendor. Using this information, the Finlay licensed business is able to monitor merchandise trends and variances in performance and improve the efficiency of our inventory management. Our merchandising and inventory control systems and point-of-sale systems for our locations have provided improved analysis and reporting capabilities. Additionally, each of the Finlay licensed business, Carlyle and Congress measure the productivity of their sales forces by maintaining current statistics for each employee such as sales per hour, transactions per hour and transaction size.

Personnel and Training.    We consider our employees an important component of our operations and devote substantial resources to training and improving the quality of sales and management personnel.

11




As of the end of 2006, we regularly employed approximately 4,500 people of which approximately 95% were regional and local sales and supervisory personnel with the balance employed in administrative or executive capacities. Of our 4,500 employees, approximately 2,000 were part-time employees, working less than 32 hours per week. Our labor requirements fluctuate because of the seasonal nature of our business. Our management believes that relations with our employees are good. Less than 1% of our employees are unionized.

Advertising.    With respect to our department store based fine jewelry business, we promote our products primarily through four-color direct mail catalogs using targeted mailing lists developed by our host stores, and newspaper advertising. We maintain an in-house advertising staff responsible for preparing the majority of our advertisements and for coordinating the finished advertisements with our host stores. We also participate in the majority of our host stores’ promotional activities including direct mail postcards and coupons. The majority of our license agreements with host store groups require us to expend certain specified minimum percentages of the respective department’s annual sales on advertising and promotional activities. With respect to our stand-alone jewelry stores, their products are promoted through direct mail, outdoor and regional print advertising and sponsorships.

Inventory Loss Prevention and Insurance.    We undertake substantial efforts to safeguard our merchandise from loss or theft, including the installation of safes and lockboxes at each location and the taking of a daily diamond inventory count. Additionally, with respect to our stand-alone jewelry stores, each store has a sophisticated security system in place. During 2006, inventory shrinkage amounted to approximately 0.5% of sales. We maintain insurance covering the risk of loss of merchandise in transit or on our premises (whether owned or on consignment) in amounts that management believes are reasonable and adequate for the types and amounts of merchandise we offer for sale.

Gold Hedging.    During the majority of 2006, and from time to time in past years, we have entered into forward contracts based upon the anticipated sales of consigned gold merchandise. These contracts aided our efforts in hedging against the risk of gold price fluctuations, as the cost of gold for our consigned gold merchandise was not fixed until the merchandise was sold, exposing us to the risk of fluctuations in the price of gold between the time we established the advertised or other retail price of a particular item and the date on which the sale of the item was reported to the vendor or the gold consignor. At February 3, 2007, we had no open positions in gold forward contracts. At January 28, 2006, we had two open positions in gold forward contracts totaling 10,000 fine troy ounces, to purchase gold for $5.1 million. Beginning in January 2007, we will purchase gold merchandise directly from our vendors under an owned inventory program.

Competition

We face competition for retail jewelry sales from national and regional jewelry chains, other department stores in which we do not operate fine jewelry departments, local independently owned jewelry stores, specialty stores, mass merchandisers, catalog showrooms, discounters, direct mail suppliers, televised home shopping and internet merchants. Our management believes that competition in the retail jewelry industry is based primarily on quality, fashion appeal and perceived value of the product offered and on the reputation, integrity and service of the retailer.

Seasonality

Our business is subject to substantial seasonal variations. Historically, we have realized a significant portion of our sales, cash flow and net income in the fourth quarter of the year principally due to sales from the holiday season. We expect that this general pattern will continue. Our results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new location openings and location closings.

12




Item 1A.    Risk Factors

Forward-Looking Information and Risk Factors that May Affect Future Results

Set forth below are certain important risks and uncertainties that could adversely affect our results of operations or financial condition and cause our actual results to differ materially from those expressed in the forward-looking statements made by us. See ‘‘Forward Looking Statements’’ in Item 7 for additional risk factors.

The loss of our relationship with Federated, or significant store closures by our host store groups, would materially adversely affect our business.

We primarily operate licensed fine jewelry departments in major department stores and, as such, our business is substantially dependent on our relationships with our host store groups, especially Federated. In 2006, our department store based fine jewelry sales were 85.8% of our total sales and approximately 57% of our total sales were generated by departments operated in store groups owned by Federated (excluding the Federated departments that closed in 2006 and Lord & Taylor). As of February 3, 2007, we operated a total of 349 departments in five of Federated’s eight divisions, which excludes 194 departments that were either divested or phased into the Macy’s East or Macy’s West divisions during the first half of 2006. Additionally, in May 2006, the Holding Company announced that Belk would not renew our license agreement due to Belk’s acquisition of a privately-held company that currently licenses fine jewelry departments in certain of the Belk stores. The termination of the license agreement, effective at the end of 2006, resulted in the closure of 75 departments. Further, in October 2006, Belk acquired Parisian from Saks. We will continue to operate the Parisian departments through August 4, 2007. A decision by Federated, or certain of our other host store groups, to terminate existing relationships, transfer the operation of some or all of their departments to a competitor, assume the operation of those departments themselves, or close a significant number of stores, would have a material adverse effect on our business and financial condition.

We may not be able to successfully expand our business or increase the number of departments we operate.

A significant portion of our historical growth in sales and income from operations has resulted from our ability to obtain licenses to operate departments in new host store groups and the addition of new departments in existing host store groups. We cannot predict the number of departments we will operate in the future.

The seasonality of the retail jewelry business makes our profitability substantially dependent on our fourth quarter results.

Our business is highly seasonal, with a significant portion of our sales and income from operations generated during the fourth quarter of each year, which includes the year-end holiday season. The fourth quarter of 2006 accounted for 42.0% of our annual sales. We have typically experienced net losses in the first three quarters of our fiscal year. During these periods, working capital requirements have been funded by borrowings under our Revolving Credit Facility. This pattern is expected to continue. A substantial decrease in sales during the fourth quarter, whether resulting from adverse weather conditions, natural disasters, supply chain problems or any other cause, would have a material adverse effect on our profitability and our financial condition.

Our locations are heavily dependent on customer traffic and the continued popularity of our host stores and malls.

The success of our locations depends, in part, on the ability of host stores to generate customer traffic in their stores, and the continuing popularity of malls and department stores as shopping destinations. Customer traffic, sales volume and earnings may be adversely affected by economic slowdowns in a particular geographic area, the closing of anchor tenants, or competition from retailers such as discount and mass merchandise stores and other department and specialty jewelry stores where we do not have locations.

13




We may not be able to successfully identify, finance, integrate or make acquisitions outside of the licensed jewelry department business.

We may from time to time examine opportunities to acquire or invest in companies or businesses that complement our existing core business, such as our acquisition of Carlyle in May 2005 and Congress in November 2006. There can be no assurance that the Carlyle or Congress acquisitions or any other future acquisitions by us will be successful or improve our operating results. In addition, our ability to complete acquisitions will depend on the availability of both suitable target businesses and acceptable financing. Any acquisitions may result in a potentially dilutive issuance of additional equity securities, the incurrence of additional debt or increased working capital requirements. Such acquisitions could involve numerous additional risks, including difficulties in the assimilation of the operations, products, services and personnel of any acquired company, diversion of our management’s attention from other business concerns, and expansion into new businesses with which we may have no prior experience.

Our substantial debt and the terms of our debt instruments could adversely affect our business.

We currently have a significant amount of debt. As of February 3, 2007, we had $200.0 million of debt outstanding under our 8 3/8% Senior Notes due June 1, 2012, having an aggregate principal amount of $200.0 million (the ‘‘Senior Notes’’). Additionally, at February 3, 2007, borrowings under the Revolving Credit Agreement were $45.9 million and we had letters of credit outstanding totaling $6.1 million under our $225.0 million Revolving Credit Facility. During 2006, our average revolver balance was $69.2 million and we peaked in usage at $175.5 million, at which point the available borrowings were an additional $37.4 million. Subject to the terms of the covenants relating to our indebtedness, we may incur additional indebtedness, including secured debt, in the future. Our high leverage could make us more vulnerable to general changes in the economy.

Our profitability depends, in part, upon our ability to continue to obtain substantial amounts of merchandise on consignment.

The willingness of vendors to enter into consignment arrangements may vary substantially from time to time based on a number of factors, including the merchandise involved, the financial resources of vendors, interest rates, availability of financing, fluctuations in gem and gold prices, inflation, our financial condition and a number of other economic or competitive conditions in the jewelry business or generally.

A decline in discretionary consumer spending may adversely affect our industry, our operations and our profitability.

Luxury products, such as fine jewelry, are discretionary purchases for consumers. Any reduction in consumer discretionary spending or disposable income may affect our industry more significantly than other industries. Many economic factors outside of our control could affect consumer discretionary spending, including the financial markets, consumer credit availability, prevailing interest rates, energy costs, employment levels, salary levels and tax rates. Any reduction in discretionary consumer spending could materially adversely affect our business and financial condition, especially if such changes were to occur in the fourth quarter of our fiscal year.

Volatility in the availability and cost of precious metals and precious and semi-precious stones could adversely affect our business.

The jewelry industry in general is affected by fluctuations in the prices of precious metals and precious and semi-precious stones. The availability and prices of gold, diamonds and other precious metals and precious and semi-precious stones may be influenced by cartels, political instability in exporting countries and inflation. Shortages of these materials or sharp changes in their prices could have a material adverse effect on our results of operations or financial condition. A significant change in prices of key commodities, including gold, could adversely affect our business by reducing operating margins and impacting consumer demand if retail prices are increased significantly.

The retail jewelry business is highly competitive.

We face competition for retail jewelry sales from national and regional jewelry chains, other department stores in which we do not operate the fine jewelry departments, local independently

14




owned jewelry stores, specialty stores, mass merchandisers, catalog showrooms, discounters, direct mail suppliers, internet merchants and televised home shopping. Some of our competitors are substantially larger and have greater financial resources than us. Competition may result in price pressure, reduced gross margins and loss of market share, any of which could substantially harm our business and results of operations.

We may not be able to collect proceeds from our host stores.

Our license agreements typically require the host stores to remit the net sales proceeds for each month to us approximately three weeks after the end of such month. However, we cannot assure you that we will timely collect the net sales proceeds due to us from our host stores. If one or more host stores fail to remit the net sales proceeds for a substantial period of time or during the fourth quarter of our fiscal year due to financial instability, insolvency or otherwise, this could have a material adverse impact on our liquidity.

We are dependent on several key vendors and other suppliers.

In 2006, approximately 43.5% of sales related to the department store based fine jewelry departments were generated by merchandise obtained from their ten largest vendors, and approximately 9.0% of sales related to the these departments were generated by merchandise obtained from their largest vendor. Merchandise obtained from our stand-alone jewelry stores two largest vendors generated approximately 44% of their sales. There can be no assurance that we can identify, on a timely basis, alternate sources of merchandise supply in the case of an abrupt loss of any of our significant suppliers. Additionally, we receive allowances from our vendors through a variety of programs and arrangements, including cooperative advertising. A significant reduction in the collection of such allowances may negatively impact our future gross margins and/or increase future selling, general and administrative expenses (‘‘SG&A’’), and may reduce future net income.

Our success depends on our ability to identify and rapidly respond to fashion trends.

The jewelry industry is subject to rapidly changing fashion trends and shifting consumer demands. Accordingly, our success depends on the priority that our target customers place on fashion and our ability to anticipate, identify and capitalize upon emerging fashion trends. If we misjudge fashion trends and are unable to adjust our product offerings in a timely manner, our net sales may decline or fail to meet expectations and any excessive inventory may need to be sold at lower prices.

We could be materially adversely affected if our distribution operations are disrupted.

In the event that our distribution facilities were to shut down or otherwise become inoperable or inaccessible for any reason, we could incur higher costs and longer lead times associated with the distribution of merchandise to our stores during the time it takes to reopen or replace the affected facility.

We are heavily dependent on our management information systems and our ability to maintain and upgrade these systems from time to time.

The efficient operation of our business is heavily dependent on our management information systems. In particular, we rely on our inventory and merchandising control systems, which allow us to make better decisions in the allocation and distribution of our merchandise. Our business and operations could be materially and adversely affected if our systems were inoperable or inaccessible or if we were not able, for any reason, to successfully restore our systems and fully execute our disaster recovery plan.

From time to time, we improve and upgrade our management information systems. If we are unable to maintain and upgrade our systems or to integrate new and updated systems in an efficient and timely manner, our business and results of operations could be materially and adversely affected.

We depend on key personnel.

Our success depends to a significant extent upon our ability to retain key personnel, particularly Arthur E. Reiner, our Chairman and Chief Executive Officer. The loss of Mr. Reiner’s services or

15




those of our current members of senior management, or our failure to attract talented new employees, could have a material adverse effect on our business.

The terms of our debt instruments and other obligations impose financial and operating restrictions.

Our Revolving Credit Agreement and the indenture relating to the Senior Notes contain restrictive covenants that will limit our ability to engage in activities that may be in our long-term best interests. These covenants include limitations on, or relating to, capital expenditures, liens, indebtedness, investments, mergers, acquisitions, affiliated transactions, management compensation and the payment of dividends and other restricted payments. As of February 3, 2007, we are in compliance with all of our covenants.

The future impact of legal and regulatory issues is unknown.

Our business is subject to government laws and regulations including, but not limited to, employment laws and regulations, state advertising regulations, quality standards imposed by federal law, and other laws and regulations. A violation or change of these laws could have a material adverse effect on our business, financial condition and results of operations. In addition, the future impact of litigation arising in the ordinary course of business may have an adverse effect on the financial results or reputation of the company.

Our stand-alone jewelry store business could be adversely affected if it is unable to successfully negotiate favorable lease terms.

All of the Carlyle and Congress stores are leased. As of February 3, 2007, Carlyle had a total of 33 stores and Congress had five stores. Carlyle’s store leases are generally for a term of ten years and Congress’ store leases have terms ranging from five to ten years, several of which have renewal options. Rent for those stores is a fixed minimum base plus, for certain of the stores, a percentage of store sales in excess of a specified threshold. Carlyle and Congress have generally been successful in negotiating leases for new stores and lease renewals. However, our stand-alone jewelry store business, financial condition, and operating results could be adversely affected if they are unable to continue to negotiate favorable new and renewal lease terms.

We could have failures in our system of internal control over financial reporting.

We maintain a documented system of internal control over financial reporting which is reviewed and monitored by management, who meet regularly with the Audit Committee of our Board of Directors. We believe we have a well-designed system to maintain adequate internal control, however, there can be no assurances that control deficiencies will not arise in the future. Although we have devoted significant resources to document, test, monitor and improve our internal control, we cannot be certain that these measures will ensure that our controls will be adequate in the future or that adequate controls will be effective in preventing fraud. Any failures in the effectiveness of our internal control over financial reporting could have a material adverse effect on the accuracy of our financial statements and our ability to detect fraud and could cause us to fail to meet reporting obligations.

Item 1B.    Unresolved Staff Comments

Not Applicable.

Item 2.    Properties

The only real estate owned by us are Finlay’s central distribution facility, totaling 106,200 square feet located in Orange, Connecticut and Carlyle’s executive and administrative office, totaling approximately 19,700 square feet located in Greensboro, North Carolina. In addition, we lease approximately 18,400 square feet at 521 Fifth Avenue, New York, New York, and 49,100 square feet at 529 Fifth Avenue, New York, New York for our executive, accounting, advertising, merchandising, information systems and other administrative functions. The leases for such space expire September 30, 2008. Generally, as part of our department store based fine jewelry license agreements, our host stores provide office space for our host store group management personnel free of charge. Congress’ 4,360 square foot executive and administrative office is located in Bonita Springs, Florida, the lease for which expires on March 31, 2011.

16




At February 3, 2007, Carlyle had a total of 33 leased stores and Congress had five leased stores, which leases expire on various dates through 2016. Carlyle’s store leases are generally for a term of ten years and Congress’ store leases have terms ranging from five to ten years, several of which have renewal options. Rent for these stores is a fixed minimum base plus, for certain of the stores, a percentage of store sales in excess of a specified threshold.

Item 3.    Legal Proceedings

From time to time, we are involved in litigation relating to claims arising out of our operations in the normal course of business. As of April 13, 2007, we are not a party to any legal proceedings that, individually or in the aggregate, are reasonably expected to have a material adverse effect on our consolidated financial statements. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on our consolidated financial statements.

Commonly in the retail jewelry industry, a substantial amount of merchandise is sold at a discount to the ‘‘regular’’ or ‘‘original’’ price. Our experience is consistent with this practice. A number of states in which we operate have regulations which require retailers who offer merchandise at discounted prices to offer the merchandise at the ‘‘regular’’ or ‘‘original’’ prices for stated periods of time. Our management believes we are in substantial compliance with all applicable legal requirements with respect to such practices.

Item 4.    Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of 2006.

17




PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

During 2006 and 2005, there were no cash dividends distributed to the Holding Company by us. During 2004, we distributed cash dividends of $39.7 million to the Holding Company. Additionally, during 2004, we repaid an intercompany tax liability due to the Holding Company totaling $43.4 million. The distributions during 2004 were generally utilized to repurchase the 9% Senior Debentures, due May 1, 2008, having an aggregate principal amount of $75.0 million (the ‘‘Old Senior Debentures’’), to pay interest on the Old Senior Debentures and to purchase the Holding Company’s common stock, par value $.01 per share (‘‘Common Stock’’), under its stock repurchase program, which expired in September 2005. Certain restrictive covenants in the indenture relating to the 8-3/8% Senior Notes, due June 1, 2012, having an aggregate principal amount of $200.0 million (the ‘‘Senior Notes’’) and the Revolving Credit Agreement impose limitations on the payment of dividends to the Holding Company. Additionally, the Senior Notes and the Revolving Credit Agreement currently restrict the amount of annual distributions to the Holding Company.

There was one record holder of our common stock at April 13, 2007.

We are a wholly-owned subsidiary of the Holding Company. Accordingly, there is no established public trading market for our common stock.

Issuer Purchases of Equity Securities

There were no repurchases of equity securities by us during the fourth quarter of 2006.

Item 6.  Selected Consolidated Financial Data

The selected consolidated financial information below should be read in conjunction with ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ and the Consolidated Financial Statements and Notes thereto. As a result of the consolidation of certain of our host store groups and the loss of certain host store license agreements, the results of operations of the stores closed during 2006 and 2003 have been segregated from those of continuing operations, net of tax, and classified as discontinued operations for all periods presented. The statement of cash flows data and balance sheet data as of and for each of the years ended February 3, 2007, January 28, 2006, January 29, 2005, January 31, 2004 and February 1, 2003 have been derived from our audited Consolidated Financial Statements. The results of operations for 2006 include Congress’ results of operations since the date of acquisition. The results of operations for 2005 include Carlyle’s results of operations since the date of acquisition.

18





  Fiscal Year Ended(1)
  Feb. 3,
2007
Jan. 28,
2006
Jan. 29,
2005
Jan. 31,
2004
Feb. 1,
2003
  (Dollars in thousands, except per share data)
Statement of Operations Data:          
Sales $ 761,795 $ 709,731 $ 646,265 $ 632,349 $ 618,698
Cost of sales 402,915 361,855 322,432 313,868 302,118
Gross margin(3) 358,880 347,876 323,833 318,481 316,580
Selling, general and administrative expenses 331,261 312,694 290,887 285,204 284,230
Credit associated with the closure of Sonab(4) (364 )  (1,432 ) 
Depreciation and amortization 15,137 14,712 14,512 14,309 14,231
Impairment of goodwill(5) 77,288
Income (loss) from operations 12,482 (56,818 )  18,798 18,968 19,551
Interest expense, net 23,512 21,950 18,120 14,862 15,660
Other expense(6) 79 5,963
Income (loss) from continuing operations before income taxes and cumulative effect of accounting change (11,030 )  (78,847 )  (5,285 )  4,106 3,891
Provision (benefit) for income taxes (4,640 )  (6,022 )  (3,672 )  1,340 1,087
Income (loss) from continuing operations before cumulative effect of accounting change (6,390 )  (72,825 )  (1,613 )  2,766 2,804
Discontinued operations, net of tax(2) 10,790 17,060 21,100 10,478 26,224
Cumulative effect of accounting change, net of tax(7) (17,209 ) 
Net income (loss) $ 4,400 $ (55,765 )  $ 19,487 $ 13,244 $ 11,819
Operating and Financial Data:  
Number of locations (end of year) 758 738 702 671 711
Percentage increase (decrease) in sales 7.3 %  9.8 %  2.2 %  2.2 %  (2.6 )% 
Percentage increase in comparable
department sales(8)
8.2 %  0.7 %  2.7 %  2.3 %  0.1 % 
Average sales per location(9) $ 1,018 $ 986 $ 941 $ 915 $ 872
EBITDA(5)(10) 27,619 (42,106 )  33,310 33,277 33,782
Most directly comparable GAAP measures:      
Net income (loss) $ 4,400 $ (55,765 )  $ 19,487 $ 13,244 $ 11,819
Cash flows provided by (used in) operating activities(11) $ (43,439 )  $ 26,248 $ (14,172 )  $ 48,279 $ 52,291
Capital expenditures $ 11,834 $ 11,869 $ 12,667 $ 12,934 $ 12,489
Cash flows provided by (used in):      
Operating activities(11) $ (43,439 )  $ 26,248 $ (14,172 )  $ 48,279 $ 52,291
Investing activities (18,094 )  (40,659 )  (12,667 )  (12,934 )  (15,750 ) 
Financing activities 35,739 (20,048 )  (685 )  (14,349 )  (17,278 ) 
Balance Sheet Data-End of Period:      
Working capital $ 253,848 $ 248,639 $ 229,886 $ 197,297 $ 173,960
Total assets 536,643 520,789 558,477 592,324 578,575
Short-term debt, including current portion of     
long-term debt
45,876
Long-term debt 200,000 200,000 200,000 150,000 150,000
Total stockholders’ equity 116,604 112,568 164,857 185,100 187,816
(1) Each of the fiscal years for which information is presented includes 52 weeks except 2006, which includes 53 weeks.
(2) As a result of the consolidation of certain of our host store groups and the loss of certain host store license agreements in 2006 and 2003, and in accordance with Statement of Financial Accounting Standards (‘‘SFAS’’) No. 144, ‘‘Accounting for the Impairment or Disposal of Long-Lived Assets’’ (‘‘SFAS No. 144’’), the results of operations of the stores closed during 2006 and 2003 have been segregated from continuing operations and reflected as discontinued operations for financial statement purposes for all periods presented. Refer to Note 13 of Notes to Consolidated Financial Statements for additional information regarding discontinued operations in 2006.
(3) We utilize the last-in, first-out (‘‘LIFO’’) method of accounting for inventories. If we had valued inventories using the first-in, first-out inventory valuation method, the gross margin would have increased as follows: $7.2 million, $2.6 million, $2.1 million, $4.5 million and $2.2 million for 2006, 2005, 2004, 2003 and 2002, respectively. During the third quarter of 2004, we changed our method of determining price indices used in the valuation of LIFO inventories.
(4) Included in Credit associated with the closure of Sonab, our former European licensed jewelry department subsidiary, for 2004 and 2002 is a $0.4 million and $1.4 million credit, respectively, which represents a revision of our estimate of closure expenses to reflect our remaining liability associated with the closure of Sonab.
(5) During the second quarter of 2005, Federated announced its intention to divest, beginning in 2006, certain stores in which we operated the fine jewelry departments. Based on this business indicator, we used our SFAS No. 142, ‘‘Goodwill and Other Intangible Assets’’ model to evaluate the carrying value of goodwill as of July 30, 2005. As a result, we determined

19




that goodwill was impaired and an impairment of $77.3 million, on a pre-tax basis, was recorded during 2005. Refer to Note 14 of Notes to Consolidated Financial Statements for additional information regarding the impairment of goodwill.
(6) Other expense for 2005 includes approximately $0.1 million associated with a loss on foreign exchange related to a refund of foreign taxes. Other expense for 2004 includes pre-tax charges of approximately $6.0 million, including $4.4 million for redemption premiums paid on the 8-3/8% Senior Notes, due May 1, 2008, having an aggregate principal amount of $150.0 million (the ‘‘Old Senior Notes’’), $1.3 million to write-off deferred financing costs related to the refinancing of the Old Senior Notes and $0.3 million for other expenses. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information regarding the debt refinancing.
(7) In accordance with the provisions of the Financial Accounting Standards Board’s (‘‘FASB’’) Emerging Issues Task Force (‘‘EITF’’) Issue No. 02-16, ‘‘Accounting by a Customer (Including a Reseller) for Cash Consideration Received from a Vendor’’ (‘‘EITF 02-16’’), we recorded a cumulative effect of accounting change as of February 3, 2002, the date of adoption, that decreased net income for 2002 by $17.2 million, net of tax of $11.7 million. The application of EITF 02-16 changed our accounting treatment for the recognition of vendor allowances. Refer to Note 2 of Notes to Consolidated Financial Statements for additional information regarding EITF 02-16.
(8) Comparable store sales are calculated by comparing sales from locations open for the same months in the comparable periods. These figures have not been restated to exclude the discontinued operations. The percentage increase in comparable store sales for 2006, excluding discontinued operations, was 2.1%
(9) Average sales per location is determined by dividing sales by the average of the number of locations open at the beginning and at the end of each period.
(10) Our definition of EBITDA is earnings before interest, taxes, depreciation and amortization. Management uses EBITDA as one of several factors in evaluating our operating performance as compared to prior years and our financial plan. We also use a variation of EBITDA to determine incentive compensation payments. We believe EBITDA provides useful information for determining our ability to meet future debt service requirements. EBITDA is also widely used by us and others in our industry to evaluate and price potential acquisitions and it is commonly used by certain investors and analysts to analyze and compare companies on the basis of operating performance and to determine a company’s ability to service and/or incur debt.
EBITDA should not be construed as a substitute for income from operations, net income or cash flows from operating activities (all as determined in accordance with generally accepted accounting principles (‘‘GAAP’’)) for the purpose of analyzing our operating performance, financial position and cash flows, as EBITDA is not defined by generally accepted accounting principles. EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for the analysis of our results as reported under GAAP. Some of these limitations include:
EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures, or contractual commitments;
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will likely require replacement in the future, and EBITDA does not reflect any cash requirements for such replacements;
EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
EBITDA does not reflect the significant interest expense, or the cash requirements necessary, to service interest or principal payments on our debt; and
Other companies in our industry may calculate EBITDA differently than we do, limiting its usefulness as a comparative measure.

Because of these limitations, EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA only supplementally. See the Statements of Cash Flows included in our consolidated financial statements.

Because we consider EBITDA useful as an operating measure, a reconciliation of EBITDA to Net income (loss) follows flor the periods indicated:


  Fiscal Year Ended
  Feb. 3,
2007
Jan. 28,
2006
Jan. 29,
2005
Jan. 31,
2004
Feb. 1,
2003
  (dollars in thousands)
EBITDA $ 27,619 $ (42,106 )  $ 33,310 $ 33,277 $ 33,782
Depreciation and amortization (15,137 )  (14,712 )  (14,512 )  (14,309 )  (14,231 ) 
Interest expense, net (23,512 )  (21,950 )  (18,120 )  (14,862 )  (15,660 ) 
Other expense (79 )  (5,963 ) 
(Provision)/benefit for income taxes 4,640 6,022 3,672 (1,340 )  (1,087 ) 
Discontinued operations 10,790 17,060 21,100 10,478 26,224
Cumulative effect of accounting change (17,209 ) 
Net income (loss) $ 4,400 $ (55,765 )  $ 19,487 $ 13,244 $ 11,819

20




Because we also consider EBITDA useful as a liquidity measure, a reconciliation of EBITDA to our net cash provided by (used in) operating activities follows for the periods indicated:

  Fiscal Year Ended
  Feb. 3,
2007
Jan. 28,
2006
Jan. 29,
2005
Jan. 31,
2004
Feb. 1,
2003
  (Dollars in thousands)
EBITDA $ 27,619 $ (42,106 )  $ 33,310 $ 33,277 $ 33,782
Impairment of goodwill 77,288
Discontinued operations, excluding write-down of goodwill and depreciation expense 14,050 21,473 23,907 28,643 29,559
Interest expense, net (23,512 )  (21,950 )  (18,120 )  (14,862 )  (15,660 ) 
Other expense (79 ) 
(Provision)/benefit for income taxes 4,640 6,022 3,672 (1,340 )  (1,087 ) 
Loss on disposal of fixed assets 6,072 182 902
Amortization of deferred financing costs 1,319 1,185 1,058 828 1,040
Amortization of restricted stock compensation
and restricted stock units
         
1,419 1,216 1,358 531 304
Credit associated with the closure of Sonab (364 )  (1,432 ) 
Deferred income tax provision (1,409 )  (5,457 )  12,235 6,759 3,982
Other (411 )  (288 )  974 (7 )  255
Changes in assets and liabilities, net of effects from purchase of Congress in 2006 and Carlyle in 2005:          
(Increase) decrease in accounts and other Receivables 4,810 (23,002 )  1,714 (7,501 )  (7,407 ) 
(Increase) decrease in merchandise Inventories (33,069 )  1,989 (5,641 )  (9,404 )  24,348
(Increase) decrease in prepaid expenses and other 87 (262 )  (362 )  664 (886 ) 
Increase (decrease) in accounts payable and accrued liabilities (45,528 )  10,050 (60,382 )  10,656 (14,471 ) 
Increase (decrease) in due to parent 474 (13 )  (8,433 )  35 (36 ) 
Net cash provided by (used in) operating activities $ (43,439 )  $ 26,248 $ (14,172 )  $ 48,279 $ 52,291
(11) Included in 2006 as a use of cash, is the increase in inventory as a result of the termination and retirement of $49.9 million under the Gold Consignment Agreement.
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (‘‘MD&A’’) is organized as follows:

  Executive Overview   —   This section provides a general description of our business and a brief discussion of the opportunities, risks and uncertainties that we focus on in the operation of our business.
  Results of Operations   —   This section provides an analysis of the significant line items on the consolidated statements of operations.
  Liquidity and Capital Resources   —   This section provides an analysis of liquidity, cash flows, sources and uses of cash, contractual obligations and financial position.
  Seasonality — This section describes the effects of seasonality on our business.
  Critical Accounting Policies and Estimates   —   This section discusses those accounting policies that are considered important to our financial condition and results of operations, and require us to exercise subjective or complex judgments in their application. In addition, all of our significant accounting policies, including critical accounting policies, are summarized in Note 2 to the Consolidated Financial Statements.
  Special Note Regarding Forward-Looking Statements   —   This section provides cautionary information about forward-looking statements and description of certain risks and uncertainties that could cause actual results to differ materially from our historical results or current expectations or projections.

This MD&A has been updated for the purpose of restating our financial statements for stores which have been treated as discontinued operations during 2006.

21




In May 2005, we completed the acquisition of Carlyle. The purchase price was approximately $29.0 million plus transaction fees and the assumption of $17.1 million of debt. The transaction was financed with additional borrowings under the Revolving Credit Agreement. Carlyle’s results of operations are included in the accompanying Consolidated Statements of Operations since the date of acquisition.

In November 2006, we completed the acquisition of Congress, a privately-owned regional chain of five jewelry stores located in southwest Florida, with annual sales of approximately $23.6 million in 2006. The purchase price was $6.0 million plus transaction fees and the assumption of $10.0 million of debt. The transaction was financed with additional borrowings under the Revolving Credit Agreement. Congress’ results of operations are included in the accompanying Consolidated Statements of Operations since the date of acquisition.

Executive Overview

Our Business

We are one of the leading retailers of fine jewelry in the United States and primarily operate licensed fine jewelry departments in major department stores where we sell a broad selection of moderately priced jewelry, with an average sales price of approximately $248 per item. We also operate stand-alone jewelry stores which sell luxury priced jewelry, with an average sales price of approximately $1,400 per item. We have two operating segments — department store based fine jewelry departments and stand-alone jewelry stores. As of February 3, 2007, we operated a total of 758 locations, including 720 department store based fine jewelry departments in eleven host store groups, in 40 states and the District of Columbia, as well as 33 Carlyle specialty jewelry stores in nine states, located principally in the southeastern United States and five Congress specialty jewelry stores in southwest Florida.

Our primary focus is to offer desirable and competitively priced products, a breadth of merchandise assortments and to provide superior customer service. Our ability to quickly identify emerging trends and maintain strong relationships with vendors has enabled us to present better assortments in our showcases. With respect to our department store based fine jewelry departments, we believe that we are an important contributor to each of our host store groups and we continue to seek opportunities to penetrate the department store segment. By outsourcing their fine jewelry departments to us, host store groups gain our expertise in merchandising, selling and marketing jewelry and customer service. Additionally, by avoiding high working capital investments typically required of the traditional retail jewelry business, host stores improve their return on investment and increase their profitability. As a licensee, we benefit from the host stores’ reputation, customer traffic, credit services and established customer base. We also avoid the substantial capital investment in fixed assets typical of a stand-alone retail format. At the end of 2006, approximately 30% of our merchandise was held on consignment, which reduces our inventory exposure to changing fashion trends. These factors have generally led our new departments to achieve profitability within the first twelve months of operation.

Our stand-alone jewelry stores offer compelling shopping environments for the high-end luxury consumer and focus on watches, gold, designer jewelry, diamonds and precious gemstones, complemented by an assortment of giftware. Our stand-alone jewelry stores each strive to provide their customers with a premier shopping experience by utilizing knowledgeable, professional and well-trained sales associates, marketing programs designed to promote customer awareness of their merchandise assortments and by extending credit to their customers through their credit card programs which are managed by a third-party.

We measure ourselves against key financial measures that we believe provide a well-balanced perspective regarding our overall financial success. Those benchmarks are as follows, together with how they are computed:

  Comparable store sales growth computed as the percentage change in sales for locations open for the same months during the comparable periods. Comparable store sales are measured against our host store groups as well as other jewelry retailers;

22




  Total net sales growth (current year total net sales minus prior year total net sales divided by prior year total net sales equals percentage change) which indicates, among other things, the success of our selection of new store locations and the effectiveness of our merchandising strategies; and
  Operating margin rate (income from operations divided by net sales) which is an indicator of our success in leveraging our fixed costs and managing our variable costs. Key components of income from operations which management focuses on include monitoring gross margin levels as well as continued emphasis on leveraging our SG&A.

2006 Highlights

During 2006, we achieved a 2.1% growth in comparable store sales. Over the past decade, through the successful execution of our marketing and merchandising strategy, we have experienced comparable store sales increases (in nine out of ten years) and we have consistently outperformed our host store groups with respect to these increases. We have an experienced management team, a well-trained and highly motivated sales force, an expert jewelry merchandising team, unique vendor relationships and an established customer base. Our merchandising and inventory control systems and point-of-sale systems for our locations provide us with a foundation for solid productivity. Total sales were $761.8 million in 2006 compared to $709.7 million in 2005, an increase of 7.3%. Total sales for 2006 included $108.2 million of sales generated by our stand-alone jewelry stores compared to $69.5 million in 2005 (which includes sales from the date of acquisition of Carlyle in May 2005 and of Congress in November 2006). Gross margin increased by $11.0 million in 2006 compared to 2005, and, as a percentage of sales, gross margin decreased by 1.9% from 49.0% to 47.1% primarily due to the increase in the LIFO provision as a result of increases in our internal price indices, as well as the increased price of gold and as a result of the discontinued business, lower vendor concessions. Although SG&A increased by $18.6 million, as a percentage of sales, SG&A decreased 0.5% from 44.0% to 43.5%, due to lower advertising and license and lease fees as well as corporate office cost savings.

During 2006, we continued to effectively manage our inventories and implement appropriate expense controls. We ended 2006 with $2.4 million of cash and borrowings under the Revolving Credit Agreement of $45.9 million, compared to $28.2 million of cash at the end of 2005. This decrease in cash and increase in borrowings was attributable to the approximately $16.0 million impact of the Congress acquisition including debt assumed, as well as the approximately $49.9 million impact as a result of the retirement of the Gold Consignment Agreement.

    In December 2006, our Revolving Credit Agreement was amended to, among other things, extend the maturity date to January 2011, allow for a facilities increase of up to $75.0 million in the aggregate, eliminate the yearly outstanding balance reduction requirement, eliminate all of the financial covenants except for the requirement to maintain a certain fixed charge ratio at certain times, and allow us to engage in business acquisitions of a certain size without obtaining prior approval of the lenders. The Revolving Credit Agreement continues to contain customary covenants relating to, among others, capital expenditures, management compensation and the payment of dividends. Refer to Note 5 of Notes to Consolidated Financial Statements. Maximum outstanding borrowings during 2006 peaked at $175.5 million, at which point the available borrowings under the Revolving Credit Agreement were an additional $37.4 million.

Effective as of November 29, 2006, we entered into an agreement to terminate and retire the obligation under the Gold Consignment Agreement, which was an off-balance sheet arrangement. In accordance with the termination agreement, we paid approximately $49.9 million to purchase the outstanding gold. The purchased gold is reflected as inventory on our Consolidated Balance Sheets from the date of purchase. Payment of the $49.9 million gold purchase price was financed through additional borrowings under the Revolving Credit Agreement.

Opportunities

We believe that current trends in jewelry retailing provide a significant opportunity for our growth. Consumers spent approximately $63.0 billion on jewelry (including both fine jewelry and

23




costume jewelry) in the United States in calendar year 2006, an increase of approximately $22.0 billion over 1996, according to the United States Department of Commerce. In the department store and specialty jewelry store sectors in which we operate, consumers spent an estimated $12.3 billion on fine jewelry in 2005.

Our management believes that demographic factors such as the maturing U.S. population and an increase in the number of working women, have resulted in greater disposable income, thus contributing to the growth of the fine jewelry retailing industry. Our management also believes that jewelry consumers today increasingly perceive fine jewelry as a fashion accessory, resulting in purchases which augment our gift and special occasion sales.

In November 2005, we signed new agreements with Federated for the Macy’s Midwest and Macy’s North divisions and amended our existing Macy’s Northwest and Macy’s South agreements, effective at the beginning of 2006. The agreements expire on January 31, 2009, and cover approximately 317 departments in total. In addition to extending our agreements for three years, all non-compete provisions from the previous May contracts that required us to obtain May’s permission before opening a new department or store within a certain radius of a May store, were eliminated. We believe that the elimination of this non-compete provision provides us with significantly greater opportunity to expand our business and continue to diversify beyond the traditional department store sector. The agreement has no impact on the Bloomingdale’s division whose license agreement, covering 32 departments, currently runs through January 30, 2010.

Additional growth opportunities exist with respect to opening departments within existing host stores that do not currently operate jewelry departments. For example, over the past three years, we have added 30 departments in Dillard’s. During 2006, we opened 15 departments within Dillard’s and we plan to add three departments in 2007. Moreover, we opened seven departments with Federated during 2006, including two Bloomingdale’s stores. Further, we opened two new Carlyle stores in 2006 and we project opening one new Carlyle store in 2007. Through opening new Bloomingdale’s departments, as well as new stand-alone stores, we will have a larger portion of our business dedicated to the high-end luxury sector.

An important initiative and focus of management is developing opportunities for our growth. We consider it a high priority to identify new businesses that offer growth, financial viability and manageability and will have a positive impact on shareholder value.

We will continue to seek to identify complementary businesses to leverage our core competencies in the jewelry industry and plan to continue to pursue the following key initiatives to further increase sales and earnings:

  Increase comparable store sales;
  Identify and acquire new businesses which diversify our existing businesses and provide additional growth opportunities;
  Add locations within our existing department store based fine jewelry and stand-alone jewelry store businesses;
  Add new host store relationships;
  Capitalize on developing fashion trends and emerging merchandise categories;
  Expand our most productive departments;
  Continue to improve operating leverage;
  Continue to raise customer service standards; and
  De-leverage the balance sheet.

See ‘‘Business-General-Growth Strategy’’ and ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’.

24




Risks and Uncertainties

The risks and challenges facing our business include:

  Dependence on or loss of certain host store relationships; and
  Host store consolidation.

As of February 3, 2007, we operated a total of 349 departments in five of Federated’s eight divisions, which excludes 194 departments either divested or phased into the Macy’s East or Macy’s West divisions during the first half of 2006. In 2006, we generated sales of approximately $105.9 million from these 194 departments. In 2005, we recorded charges of approximately $3.8 million related to the accelerated depreciation of fixed assets and severance related to these departments. During 2006, we recorded charges of $4.1 million related to the accelerated depreciation of fixed assets and severance for our field operations with respect to these departments.

During 2006, approximately 57.0% of our sales were generated by departments operated in store groups owned by Federated (excluding the Federated departments that closed in 2006 and Lord & Taylor). A decision by Federated or certain of our other host store groups to terminate our existing relationships, to assume the operation of departments themselves, or to close a significant number of stores would have a material adverse effect on our business and financial condition.

In May 2006, the Holding Company announced that Belk would not renew our license agreement due to Belk’s acquisition of a privately-held company that currently licenses fine jewelry departments in certain of the Belk stores. The termination of the license agreement, effective at the end of 2006, resulted in the closure of 75 departments. In 2006, we generated sales of approximately $51.9 million from the Belk departments. During 2006, we recorded charges of approximately $0.3 million related to the accelerated depreciation of fixed assets and severance related to our field operations with respect to these departments.

Further, as a result of Belk’s acquisition of Parisian from Saks in October 2006, the Parisian departments will close in July 2007. In 2006, we generated sales of approximately $22.9 million from our 33 Parisian departments. During 2006, we recorded charges of approximately $0.2 million related to the accelerated depreciation of fixed assets with respect to these departments.

25




Results of Operations

The following table sets forth operating results as a percentage of sales for the periods indicated. The discussion that follows should be read in conjunction with the following table:


  Fiscal Year Ended
  Feb. 3,
2007
Jan. 28,
2006
Jan. 29,
2005
Statement of Operations Data:      
Sales 100 %  100 %  100 % 
Cost of sales 52.9 51.0 49.9
Gross margin 47.1 49.0 50.1
Selling, general and administrative expenses 43.5 44.0 45.0
Credit associated with the closure of Sonab
Depreciation and amortization 2.0 2.1 2.2
Impairment of goodwill (1) 10.9
Income (loss) from operations 1.6 (8.0 )  2.9
Interest expense, net 3.0 3.1 2.8
Other expense (2) 0.9
Loss from continuing operations before income taxes (1.4 )  (11.1 )  (0.8 ) 
Benefit for income taxes (0.6 )  (0.8 )  (0.6 ) 
Loss from continuing operations (0.8 )  (10.3 )  (0.2 ) 
Discontinued operations, net of tax (3) 1.4 2.4 3.2
Net income (loss) 0.6 %  (7.9 )%  3.0 % 
(1) See Note 5 to ‘‘Selected Consolidated Financial Data’’.
(2) See Note 6 to ‘‘Selected Consolidated Financial Data’’.
(3) See Note 2 to ‘‘Selected Consolidated Financial Data’’.

2006 Compared with 2005

Sales.    Sales increased $52.1 million, or 7.3%, in 2006 compared to 2005. Sales include $653.6 million from the department store based fine jewelry departments which represented a 2.1% increase compared to the $640.2 million in sales for 2005. Sales also include $108.2 million generated by our stand-alone jewelry stores in 2006 compared to $69.5 million in 2005 (which includes sales from the date of acquisition of Carlyle in May 2005 and of Congress in November 2006). Comparable store sales increased 2.1%.

During 2006, we opened 26 Finlay departments within existing host store groups and two Carlyle stores as well as five stores as a result of the Congress acquisition. Additionally, in 2006, we closed 283 Finlay departments and one Carlyle store. The openings were comprised of the following:


Store Group Number of
Locations
Dillard’s 15
Federated 7
Congress stores 5
Carlyle stores 2
Other 4
Total 33

26




The closings were comprised of the following:


Store Group Number of
Locations
Reason
Federated 194 Stores were divested or phased into the Macy’s East or Macy’s West divisions as a result of the Federated/May merger and are included in discontinued operations.
Belk 75 Department closings as a result of Belk’s decision not to renew our license agreement and are included in discontinued operations.
Carlyle stores 1 Management’s decision to close an unprofitable location.
Other 14 Department closings within existing host store groups.
Total 284  

Our major merchandise categories include diamonds, gold, gemstones, watches and designer jewelry. With respect to Finlay’s licensed department business, designer sales increased $9.9 million, or 24.9%, in 2006 compared to 2005, due primarily to increased consumer demand.

Gross margin.    Gross margin increased by $11.0 million in 2006 compared to 2005. As a percentage of sales, gross margin decreased by 1.9% from 49.0% to 47.1%. The components of this net decrease in gross margin are as follows:


Component % Reason
Merchandise cost of sales (1.4 )%  Increase in merchandise cost of sales is due to the increased price of gold, lower vendor concessions and the mix of sales with higher sales in the diamond, designer and clearance categories, which have lower margins than other categories.
LIFO (0.6 )  Increase in the LIFO provision is due to increases in our internal price indices.
Other 0.1 Decrease in various other components of cost of sales.
Total decrease 1.9 %   

Selling, general and administrative expenses.    The components of SG&A include payroll expense, license fees, rent expense, net advertising expenditures and other field and administrative expenses.

27




SG&A increased $18.6 million, or 5.9%. SG&A dollars have increased as 2006 includes a full year of Carlyle’s SG&A. Additionally certain expenses for the department store based fine jewelry departments increase with higher sales, such as rent and sales commissions. As a percentage of sales, SG&A decreased by 0.5% from 44.0% to 43.5%. The components of this decrease in SG&A are as follows:


Component % Reason
Net advertising expenditures