Friedman’s Looks to Ease Growing Pains

Fiscal 1997 was another strong year for Friedman’s Jewelers. The Savannah, Ga.-based strip mall jeweler continued its aggressive expansion, opening 83 stores in the year ended Sept. 30. Since then, the nation’s third largest jewelry chain has added more than 40 additional locations, giving it 425 as of late January. Total revenues increased 23.5% to $237.3 million. Net income rose a phenomenal 39.3%.

The retailer set the stage for future growth last summer by settling its long-standing litigation with Augusta, Ga.-based rival A.A. Friedman and acquiring all rights to the Friedman’s name. (A.A. Friedman converted its corporate name and all of its stores to the Marks & Morgan banner as part of the agreement.) According to Friedman’s, the agreement will ultimately open up more than 100 locations in its core Southeastern markets that were previously inaccessible.

In the past 18 months, Friedman’s, a public company, has also invested $25 million into privately held, 140-store chain Crescent Jewelers of Oakland, Calif. Friedman’s and Crescent share the same ownership control, the Morgan Schiff Group, and some of the same management. Friedman’s executives say that Crescent, which has struggled in recent years, is back on a positive track with expansion plans as ambitious as its East Coast counterpart.

But rapid expansion at Friedman’s in recent years has not come without cost. Comparable store sales decreased 1.5% for the year, return on investment was down, and bad debt levels rose to 9.7% of total revenues from 8.1% in fiscal 1996.

In response, Friedman’s has shored up its management structure. In January, the company named former Blockbuster Entertainment executive Richard Ungaro as its new co-vice chairman and chief executive officer, and Linda McFarland Jenkins, former executive of specialty apparel chain Cato Corp., as executive president and chief operating officer. Ungaro takes over the CEO post from Bradley J. Stinn, who remains chairman of Friedman’s (as well as chairman and CEO of Crescent), while Jenkins succeeds Robert S. Morris, who was named co-vice chairman.

In this exclusive interview by Glen Beres, editor in chief of JCK’s High-Volume Jeweler, Stinn talked about the “growing pains” that Friedman’s has experienced, the strategies the company is implementing to regain its momentum and its continuing relationship with Crescent.

HVJ: Why have you restructured the Friedman’s management team?

BJS: We have grown Friedman’s from 50 stores to 425 stores in a short period of time. When you go through that type of growth, you can’t expect to do everything perfectly. Over the prior year, we got a little thin and our span of control got over-extended. Our existing team did a fabulous job, but we needed to bring in some talented people who had skill sets that we did not have. We believe we can teach the new people the jewelry business and how we make money; I think we know both of those things well. [Ungaro and Jenkins] are both great leaders; Rich in particular understands managing operations of scale. Linda is an excellent businessperson and is a merchant by background. Their skills, when combined with Bob [Morris’] skills and [Chief Financial Officer] Vic Suglia’s skills and whatever I can add, will give us a better and deeper team on the field.

HVJ: Some say that Friedman’s has been so focused on expansion, it has neglected its infrastructure, particularly its inventory management systems. How would you respond to that assessment?

BJS: That’s probably true. We’re not as sophisticated with our systems as we could be for a company our size. Therein lies an opportunity for improvement. But I also don’t think it’s an excuse in this business. When your inventory only turns a little more than one time [per year] and a very limited number of your SKUs account for a significant part of your business, not having the most state-of-the-art computer systems isn’t an excuse for not having inventory in your stores. We do not allow people to use the system as an excuse.

HVJ: What are your infrastructure plans for Friedman’s in 1998?

BJS: The big one is adding to the leadership of the company. From that will follow a lot of changes. When you do what we’ve done [rapidly expand], you’re never going to do everything right; you’re going to make mistakes that need to be fixed. Just finding where we’ve made mistakes is the easy part. Management’s job is to understand what has made the company great, keep it and fix some of the other problems. We have lots of areas we can manage better, but we also do a number of things very well. And even though we haven’t been executing as well as we would like – 1997 was “two steps forward, one step back” in some respects – we still were tremendously profitable.

HVJ: Nevertheless, operating results for Friedman’s were below expectations last year, with same-store sales down and bad debt levels up. What caused the problems and what are you doing to improve these areas in 1998?

BJS: We moved a little beyond what we thought were acceptable limits of credit losses for two major reasons: the sheer amount of unit growth and the fact that we expanded in the worst credit environment in the last 20 years, with personal bankruptcies and consumer delinquencies soaring. So we tweaked our program a little. We changed the underwriting to tighten the model and spent a lot of time training on collection processes. What typically happens when you go through a credit makeover is that sales suffer for a short period of time until you get to an equilibrium, and then you can build back the business. At this point, credit is not an issue in our minds. We have it under control.

HVJ: Considering your rapid rate of expansion into new markets, did competition also play a role in your disappointing performance last year?

BJS: It was a big factor. Our competition over the past year got a lot better. In particular, Zales and Kay have continued to get better and more competitive. I give them a lot of credit for that. But by the same token, our philosophy is that we affect our results more than anything else, either positively or negatively.

HVJ: In your 1997 year-end report, you talked about “enhancing overall profitability” for Friedman’s in 1998. How will you achieve this?

BJS: By putting a better team on the field, we believe sales and the productivity of our people will be better as a result. Also, because we’ve gotten to terra firma on the credit side over the past year, we believe we’ll have higher profitability going forward – even on the same sales level.

HVJ: When you grow so quickly, how difficult is it to remain profitable in your existing stores?

BJS: Doing what we’ve done over the last five years has clearly affected our performance in any one existing store. If we still had 50 stores, we’d probably be running them better than we’re running those stores today. Having said that, we wouldn’t have the 375 other stores that we’re happy with. So at all times, there are trade-offs. The question is, what is the appropriate rate of growth? Not growing at all suggests that you’re completely maxed out everywhere in the country, you don’t have the confidence to take your formula to other places or you don’t have the capital. Should we have grown at a 48% compound annual rate over the last five years? Maybe not. Would we have made fewer mistakes if we had only grown at 20%? Probably. But would we have a much smaller business? Certainly.

HVJ: Your average volume per store at Friedman’s dropped to approximately $695,000 in fiscal 1997 from $745,000 in fiscal 1996. Do you have a target volume you want to achieve in 1998?

BJS: We probably should, but we don’t. We really don’t focus on volume as much as we do on return on investment. The target for the entire company is a 30% pre-tax return on invested capital. If you look at the five fiscal years from 1993 to 1997, our average was in the 28% range. That would rank us very high in terms of not only retail jewelers, but retailers generally. Last year, our profitability was in the low 20% range. That is not acceptable. In order to get to our target [in 1998], volume has to increase, expenses need to stay under control, capital investment needs to be right, credit needs to perform properly, etc. Volume is only one component. The question is, what amount of volume do you want to do and still get a good result?

HVJ: Last May, your company acquired all rights to the “Friedman’s Jewelers” name from A.A. Friedman [now Marks & Morgan]. At the time, you said the agreement would clear up historical confusion between the two companies and open up expansion opportunities for Friedman’s. Has this been the case?

BJS: A.A. Friedman did change the name of all of its stores and we began opening stores in those markets in January. But we haven’t gotten the full benefit of the agreement yet, because we don’t have unrestricted freedom of operation in those markets until January 1999. In fact, there might have been some detriment, because [A.A. Friedman] advertised that they were changing their name. We had a lot of people walk into our stores at Christmas time and say, “I thought you were changing the name of your store.” So in the short run, [the agreement] probably is causing some additional confusion. But starting in January 1999, we’ll be able to expand wherever and whenever we want, and we’ll reap the benefits of that transaction.

HVJ: How many new Friedman’s stores do you plan to open this year?

BJS: We’ll open 70 to 90 stores. We ended the fiscal year with 384 and Christmas with 425. That’s 41 stores in about 12 weeks. That was a lot. So we’re about halfway into our expansion plans for the year.

HVJ: Will Friedman’s continue to expand regionally, or are you looking to become a national retailer?

BJS: We’re a public company. We need to keep growing as much as we can, as quickly as we can, and stay properly managed. That’s the pact you make with the public shareholders. We wouldn’t have invested in new management people if we were going to stop our expansion program. We’ll go wherever we can have a good business. But most likely we will continue to grow in areas contiguous to our existing markets.

HVJ: The company’s previous growth has been internally driven [new store openings]. Would you consider acquisitions as well?

BJS: We look at acquisitions all the time. As you get bigger, in order to make an impact on the bottom line, the things you take on need to be bigger, so some acquisitions may be down the road for Friedman’s.

HVJ: What about new formats?

BJS: We’re always looking at what others are doing. Zales’ catalog business, for instance, seems to be doing pretty well, and that might be an opportunity for us, too. I think you’ll see some different things come out of Savannah, but none that we’re prepared to talk about this year.

HVJ: What is the biggest difference operating a strip center-driven business as opposed to a mall-driven one?

BJS: You need to be more focused on customer service. You don’t have the built-in traffic that mall jewelers do, so you need to make yourself more of a destination. You do that fundamentally by treating people right, getting them to want to come back. You have fewer customers walking past your door every day, so you have to compel them to open the door.

HVJ: Considering your recent problems at Friedman’s and the historical problems at Crescent, aren’t you worried that the $25 million investment in Crescent could come back to haunt Friedman’s?

BJS: The number one fallacy is that the Crescent investment has kept Friedman’s from doing something it would have otherwise done. That is flat-out wrong. If that money didn’t go into Crescent, it would be in the bank now, earning interest. From an investment point of view, this investment was accretive to earnings per share, excluding the upside potential of the equity commitment. And we were very familiar with the Crescent business because of our overlapping ownership and management. As a result, due diligence was very complete. I’m very bullish on the investment because it’s structured to have very little downside risk [for Friedman’s]. It’s secured and at the same time it’s got tremendous equity potential. It’s a great deal for both companies.

HVJ: Can Crescent stand on its own apart from Friedman’s?

BJS: Absolutely. Morgan Schiff purchased Crescent in 1988 and Friedman’s in 1990. Both deals were [leveraged buyouts]. In the 10 years since the LBO, Crescent has had four CEOs and, exclusive of LBO interest expense, would have been profitable over that 10-year period. The LBO interest expense caused [Crescent’s] cash flow problems, but the root cause of the company’s problems has been a lack of consistency of operation. Other than the financial investment, both companies stand on their own right now. Morgan Schiff supports both companies, will continue to build both companies, and will build them independently, even if they’re merged at some point down the road.

HVJ: Is a merger between Friedman’s and Crescent a serious consideration?

BJS: It’s been 10 years since the leveraged buyout, and Crescent shareholders need to see a financial return. So Crescent has two considerations: to get liquidity for the investors by going public as an independent company or by merging into some other entity, Friedman’s being most likely.

HVJ: What will be your personal role in Friedman’s and Crescent going forward?

BJS: We believe the CEO needs to be on-site, so I’ll stay primarily at Crescent. At Friedman’s, I’ve given up my day-to-day responsibilities in exchange for a non-executive chairman’s role. At Crescent, our objective is to build our management team, so I will probably give up certain titles as we go along. But we can’t do that at Crescent until the financial condition of the company matches the improvement in operating results. [Crescent has] made a dramatic turnaround in the marketplace. What we haven’t done yet is fix the balance sheet. That’s the objective this year.

The greatest challenge for Friedman’s this year is “to properly integrate the new people with our existing people and to have the resulting team be better than what we had before. What is critical is for everybody to get on the same page and combine the best of the new ideas with the old that worked. From that will flow a lot of opportunities.”